valuation 방법
DESCRIPTION
EsTRANSCRIPT
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*Managing for Value Creation(Summer 2006)
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Class #1b OutlineReviewClass #1aLectureOverview of business valuationClass discussionEskimo Pie Corp. Case
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Overview of Business ValuationBasic Inc. CaseBusiness valuation in a perfect world
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Business ValuationValuation MethodRelevant Cash flowAppropriate Discount Rate
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Basic, Inc. (the setup)Investors have raised $600m to start Basic, Inc. ($317.44m in 9% bonds and the balance in equity).Basic is expected to produce $500m in sales annually with net income of $50m forever. All the firms net income will be paid in dividends.Annual Capex = depreciation expense and NWC does not change.No debt is issued or retired.
Finite
YearEquity Cash FlowDebt Cash FlowOperating Cash Flow
1998502070
1999543690
20005743100
20016169130
20026674140
20037080150
20047585160
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$247.94$305.91$553.84
Kwacc10.1947%
Entity Value$551.58
Exhibit 5.7
ROIC15.00%
growth (NOPLAT)6.00%
Investment Rate40.00%
Kwacc10.00%
Firm Value$1,118.61
NOPLATNet InvestmentFree Cash Flow
Year100
1106.0042.4063.60
2112.3644.9467.42
3119.1047.6471.46
4126.2550.5075.75
5133.8253.5380.29
6141.8556.7485.11
7150.3660.1590.22
8159.3863.7595.63
9168.9567.58101.37
10179.0871.63107.45
11189.8375.93113.90
12201.2280.49120.73
13213.2985.32127.98
14226.0990.44135.65
15239.6695.86143.79
16254.04101.61152.42
17269.28107.71161.57
18285.43114.17171.26
19302.56121.02181.54
20320.71128.29192.43
21339.96135.98203.97
22360.35144.14216.21
23381.97152.79229.18
24404.89161.96242.94
25429.19171.67257.51
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Infinite
Equity Cash FlowDebt Cash FlowOperating Cash Flow
Perpetuity502070
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$333.33$317.46$650.79
Kwacc10.7561%
Entity Value$650.79
Cost of Capital Calculation: Market Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.48780.06300.0307
0.51220.15000.0768
0.1076
Cost of Capital Calculation: Book Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.52910.06300.0333
Equity (book)0.47090.15000.0706
0.1040
Total Book Assets600
673.28
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FreeCashFlows
Assumptions:
Cost of Equity15.00%
Cost of debt, Kd9.00%Debt is perpetual
CAPEX$10.00All cash flows are level perpetuals
Depreciation Expense$10.00Current market rate of interest = the interest rate on debt.
Tax Rate30%Dividend payout = 100%
Dividends = Net Income$50.00
Balance Sheet
Assets$600.00
Debt$317.44
Equity282.56
Debt + Equity$600.00
Income StatementCalculation of Firm Free Cash Flow
Revenues$500.00
less: COGS(300.00)
Gross Profit200.00
less Operating Expense(100.00)EBIT100.00
EBIT100.00less: Taxes(30.00)
less: Interest(28.57)NOPAT70.00
EBT71.43plus: Depr.10.00
less: Taxes(21.43)less: CAPEX(10.00)
NI$50.00Firm FCF70.00
Calculation of Equity Free Cash Flow
NI50.00EFCF50.00
plus: Depreciation Expense10.00plus: Int(1-T)20.00
less: CAPEX(10.00)Firm FCF70.00
Equity Free Cash Flow50.00
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MVA-EVA Analysis
Tax Rate30%
EBIT100.00
Kwacc10.76%
Invested Capital600.00
NOPAT = EBIT(1-T)70.00
EVA = NOPAT - Kwacc x Invested Capital5.46
MVA = EVA / Kwacc50.79
Firm Value = MVA + Invested Capital650.79
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Sheet6
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Sheet7
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Sheet8
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Sheet9
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Sheet10
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Sheet11
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Sheet12
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Sheet13
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Sheet14
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Sheet15
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Sheet16
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Business Valuation
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Equity Free Cash FlowNet IncomePlus: Depreciation ExpenseLess: Debt RepaymentPlus: New debt issuedLess: Investment in Working CapitalLess: Capital Expenditures (Capex)Equals: Equity Free Cash Flow (EFCF)
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EFCF CalculationRecall that there are no new debt issues nor is debt retired and NWC does not change.
Finite
YearEquity Cash FlowDebt Cash FlowOperating Cash Flow
1998502070
1999543690
20005743100
20016169130
20026674140
20037080150
20047585160
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$247.94$305.91$553.84
Kwacc10.1947%
Entity Value$551.58
Exhibit 5.7
ROIC15.00%
growth (NOPLAT)6.00%
Investment Rate40.00%
Kwacc10.00%
Firm Value$1,118.61
NOPLATNet InvestmentFree Cash Flow
Year100
1106.0042.4063.60
2112.3644.9467.42
3119.1047.6471.46
4126.2550.5075.75
5133.8253.5380.29
6141.8556.7485.11
7150.3660.1590.22
8159.3863.7595.63
9168.9567.58101.37
10179.0871.63107.45
11189.8375.93113.90
12201.2280.49120.73
13213.2985.32127.98
14226.0990.44135.65
15239.6695.86143.79
16254.04101.61152.42
17269.28107.71161.57
18285.43114.17171.26
19302.56121.02181.54
20320.71128.29192.43
21339.96135.98203.97
22360.35144.14216.21
23381.97152.79229.18
24404.89161.96242.94
25429.19171.67257.51
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Infinite
Equity Cash FlowDebt Cash FlowOperating Cash Flow
Perpetuity502070
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$333.33$317.46$650.79
Kwacc10.7561%
Entity Value$650.79
Cost of Capital Calculation: Market Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.48780.06300.0307
0.51220.15000.0768
0.1076
Cost of Capital Calculation: Book Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.52910.06300.0333
Equity (book)0.47090.15000.0706
0.1040
Total Book Assets600
673.28
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FreeCashFlows
Givens:
Cost of debt, Kd9.00%Debt is perpetual
CAPEX10.00All cash flows are level perpetuals
Depreciation Expense10.00Current market rate of interest = the interest rate on debt.
Tax Rate30%Dividend payout = 100%
Balance Sheet
Assets600.00
Debt317.46
Equity282.54
Debt + Equity600.00
Income Statement
Revenues500.00
less: COGS(300.00)Calculation of Firm Free Cash Flow
Gross Profit200.00
less Operating Expense(100.00)EBIT$100.00
EBIT100.00less: Taxes(30.00)
less: Interest(28.57)NOPAT70.00
EBT71.43plus: Depr.10.00
less: Taxes(21.43)less: CAPEX(10.00)
NI50.00Firm FCF$70.00
Calculation of Equity Free Cash Flow
NI$50.00
plus: Depreciation Expense10.00
less: CAPEX(10.00)
Equity Free Cash Flow$50.00
or
EFCF$50.00
plus: Int(1-T)20.00
Firm FCF$70.00
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MVA-EVA Analysis
Tax Rate30%
EBIT100.00
Kwacc10.76%
Invested Capital600.00
NOPAT = EBIT(1-T)70.00
EVA = NOPAT - Kwacc x Invested Capital5.46
MVA = EVA / Kwacc50.79
Firm Value = MVA + Invested Capital650.79
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Sheet6
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Sheet7
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Sheet8
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Sheet9
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Sheet10
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Sheet11
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Sheet12
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Sheet13
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Sheet14
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Sheet15
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Security ValuationDebt value
Equity value
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Firm Value Firm Value = Debt Value + Equity Value
$650.77 = $317.44 + $333.33
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Business Valuation
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Firm Free Cash Flow (FFCF)Net Operating Income (NOI)Less: Taxes on Incremental NOIEquals: Net Operating Profit after TaxPlus: Depreciation ExpenseLess: Investment in Working CapitalLess: Capital Expenditures (Capex)Equals: (Firm) Free Cash Flow
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How does FFCF compare to payments made to financial claimants?Financial Claimant:Payment:CreditorsAfter-tax interest plus principal payments less new debt issued.StockholdersCommon dividends plus share repurchases less new shares issued.
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Free Cash Flow CalculationsFirm Free Cash Flow (FFCF)
Equity Free Cash Flow (EFCF)Used to value a levered firm or entity value and the equity of an unlevered firm.Used to value the common equity of a levered firm.
Finite
YearEquity Cash FlowDebt Cash FlowOperating Cash Flow
1998502070
1999543690
20005743100
20016169130
20026674140
20037080150
20047585160
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$247.94$305.91$553.84
Kwacc10.1947%
Entity Value$551.58
Exhibit 5.7
ROIC15.00%
growth (NOPLAT)6.00%
Investment Rate40.00%
Kwacc10.00%
Firm Value$1,118.61
NOPLATNet InvestmentFree Cash Flow
Year100
1106.0042.4063.60
2112.3644.9467.42
3119.1047.6471.46
4126.2550.5075.75
5133.8253.5380.29
6141.8556.7485.11
7150.3660.1590.22
8159.3863.7595.63
9168.9567.58101.37
10179.0871.63107.45
11189.8375.93113.90
12201.2280.49120.73
13213.2985.32127.98
14226.0990.44135.65
15239.6695.86143.79
16254.04101.61152.42
17269.28107.71161.57
18285.43114.17171.26
19302.56121.02181.54
20320.71128.29192.43
21339.96135.98203.97
22360.35144.14216.21
23381.97152.79229.18
24404.89161.96242.94
25429.19171.67257.51
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Infinite
Equity Cash FlowDebt Cash FlowOperating Cash Flow
Perpetuity502070
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$333.33$317.46$650.79
Kwacc10.7561%
Entity Value$650.79
Cost of Capital Calculation: Market Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.48780.06300.0307
0.51220.15000.0768
0.1076
Cost of Capital Calculation: Book Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.52910.06300.0333
Equity (book)0.47090.15000.0706
0.1040
Total Book Assets600
673.28
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FreeCashFlows
Givens:
Cost of debt, Kd9.00%Debt is perpetual
CAPEX10.00All cash flows are level perpetuals
Depreciation Expense10.00Current market rate of interest = the interest rate on debt.
Tax Rate30%Dividend payout = 100%
Balance Sheet
Assets600.00
Debt317.46
Equity282.54
Debt + Equity600.00
Income Statement
Revenues500.00
less: COGS(300.00)Calculation of Firm Free Cash Flow
Gross Profit200.00
less Operating Expense(100.00)Net Operating Income (NOI)$100.00
EBIT100.00less: Taxes(30.00)
less: Interest(28.57)NOPAT70.00
EBT71.43plus: Depr.10.00
less: Taxes(21.43)less: CAPEX(10.00)
NI50.00Firm Free Cash Flow (FFCF)$70.00
Calculation of Equity Free Cash Flow
Net Income (NI)$50.00
plus: Depreciation Expense10.00
less: CAPEX(10.00)
Equity Free Cash Flow (EFCF)$50.00
or
EFCF$50.00
plus: Int(1-T)20.00
FFCF$70.00
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MVA-EVA Analysis
Tax Rate30%
EBIT100.00
Kwacc10.76%
Invested Capital600.00
NOPAT = EBIT(1-T)70.00
EVA = NOPAT - Kwacc x Invested Capital5.46
MVA = EVA / Kwacc50.79
Firm Value = MVA + Invested Capital650.79
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Sheet6
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Sheet7
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Sheet9
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Basic, Inc.s WACCFinancing proportions are based on market values calculated earlier!
Finite
YearEquity Cash FlowDebt Cash FlowOperating Cash Flow
1998502070
1999543690
20005743100
20016169130
20026674140
20037080150
20047585160
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$247.94$305.91$553.84
Kwacc10.1947%
Entity Value$551.58
Exhibit 5.7
ROIC15.00%
growth (NOPLAT)6.00%
Investment Rate40.00%
Kwacc10.00%
Firm Value$1,118.61
NOPLATNet InvestmentFree Cash Flow
Year100
1106.0042.4063.60
2112.3644.9467.42
3119.1047.6471.46
4126.2550.5075.75
5133.8253.5380.29
6141.8556.7485.11
7150.3660.1590.22
8159.3863.7595.63
9168.9567.58101.37
10179.0871.63107.45
11189.8375.93113.90
12201.2280.49120.73
13213.2985.32127.98
14226.0990.44135.65
15239.6695.86143.79
16254.04101.61152.42
17269.28107.71161.57
18285.43114.17171.26
19302.56121.02181.54
20320.71128.29192.43
21339.96135.98203.97
22360.35144.14216.21
23381.97152.79229.18
24404.89161.96242.94
25429.19171.67257.51
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Infinite
Equity Cash FlowDebt Cash FlowOperating Cash Flow
Perpetuity5019.99969.999
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$333.33$317.44$650.78
Kwacc10.7562%
Entity Value$650.78
Cost of Capital Calculation: Market Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.48780.06300.0307
Equity0.51220.15000.0768
WACC10.76%
Cost of Capital Calculation: Book Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.52910.06300.0333
Equity (book)0.47090.15000.0706
0.1040
Total Book Assets600
673.27
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FreeCashFlows
Givens:
Cost of debt, Kd9.00%Debt is perpetual
CAPEX10.00All cash flows are level perpetuals
Depreciation Expense10.00Current market rate of interest = the interest rate on debt.
Tax Rate30%Dividend payout = 100%
Balance Sheet
Assets600.00
Debt317.46
Equity282.54
Debt + Equity600.00
Income Statement
Revenues500.00
less: COGS(300.00)Calculation of Firm Free Cash Flow
Gross Profit200.00
less Operating Expense(100.00)EBIT100.00
EBIT100.00less: Taxes(30.00)
less: Interest(28.57)NOPAT70.00
EBT71.43plus: Depr.10.00
less: Taxes(21.43)less: CAPEX(10.00)
NI50.00Firm FCF70.00
Calculation of Equity Free Cash Flow
NI50.00
plus: Depreciation Expense10.00
less: CAPEX(10.00)
Equity Free Cash Flow50.00
or
EFCF50.00
plus: Int(1-T)20.00
Firm FCF70.00
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MVA-EVA Analysis
Tax Rate30%
EBIT100.00
Kwacc10.76%
Invested Capital600.00
NOPAT = EBIT(1-T)70.00
EVA = NOPAT - Kwacc x Invested Capital5.46
MVA = EVA / Kwacc50.79
Firm Value = MVA + Invested Capital650.79
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Sheet7
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Sheet8
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Sheet9
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Entity Valuation
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EVA, MVA and Firm ValueEconomic Value Added (EVA)EVA = NOPAT - Kwacc x Invested Capital= $70 - .1076 x $600 = $70.00 - 64.54 = $5.46Market Value Added (MVA) = PV(EVAs) MVA = $5.46/.1076 = $50.78Firm Value = MVA + Invested Capital = $50.78 + 600.00 = $650.78NPVfirm=Firm Value - Invested Capital = MVA
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Business Valuation
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Adjusted Present Value Model
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Calculating Unlevered EFCFFirm Free Cash Flow (FFCF)Net Operating Income (NOI)Less: Taxes on Incremental NOIEquals: Net Operating Profit after TaxPlus: Depreciation ExpenseLess: Investment in Working CapitalLess: (Capex)Equals: (Firm) Free Cash FlowUnlevered Firms EFCFNet Operating Income (NOI)Less: Taxes on Incremental NOIEquals: Net Operating Profit after Tax and firm Net IncomePlus: Depreciation ExpenseLess: Investment in Working CapitalLess: (Capex)Equals: (Unlevered) Free Cash FlowNote that for the unlevered firm there is no new debt issued or retired.
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APV Valuation for Basic Inc.Kd=rf+bd(Market Risk Premium).09 = .08 + bd(.07)bd = .14Vu = $70/.126 = $555.56VITS = ($28.57 x .3)/.09 = $95.24
Inputs and FreeCashFlows
Givens:
Cost of debt, Kd9.00%Debt is perpetual
CAPEX10.00All cash flows are level perpetuals
Depreciation Expense10.00Current market rate of interest = the interest rate on debt.
Tax Rate30%Dividend payout = 100%
Beta coefficient1.00Levered Beta
Market risk premium7%
Risk free rate`8%
Balance Sheet
Assets600.00Cost of equity, Ke15%
Debt317.46
Equity282.54
Debt + Equity600.00
Income Statement
Revenues500.00
less: COGS(300.00)Calculation of Firm Free Cash Flow
Gross Profit200.00
less Operating Expense(100.00)EBIT100.00
EBIT100.00less: Taxes(30.00)
less: Interest(28.57)NOPAT70.00
EBT71.43plus: Depr.10.00
less: Taxes(21.43)less: CAPEX(10.00)
NI50.00Firm FCF70.00
Calculation of Equity Free Cash Flow
NI50.00
plus: Depreciation Expense10.00
less: CAPEX(10.00)
Equity Free Cash Flow50.00
or
EFCF50.00
plus: Int(1-T)20.00
Firm FCF70.00
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Finite
YearEquity Cash FlowDebt Cash FlowOperating Cash Flow
1998502070
1999543690
20005743100
20016169130
20026674140
20037080150
20047585160
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$247.94$305.91$553.84
Kwacc10.1947%
Entity Value$551.58
Exhibit 5.7
ROIC15.00%
growth (NOPLAT)6.00%
Investment Rate40.00%
Kwacc10.00%
Firm Value$1,118.61
NOPLATNet InvestmentFree Cash Flow
Year100
1106.0042.4063.60
2112.3644.9467.42
3119.1047.6471.46
4126.2550.5075.75
5133.8253.5380.29
6141.8556.7485.11
7150.3660.1590.22
8159.3863.7595.63
9168.9567.58101.37
10179.0871.63107.45
11189.8375.93113.90
12201.2280.49120.73
13213.2985.32127.98
14226.0990.44135.65
15239.6695.86143.79
16254.04101.61152.42
17269.28107.71161.57
18285.43114.17171.26
19302.56121.02181.54
20320.71128.29192.43
21339.96135.98203.97
22360.35144.14216.21
23381.97152.79229.18
24404.89161.96242.94
25429.19171.67257.51
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WACC and Valuation
Equity Cash FlowDebt Cash FlowOperating Cash Flow
Perpetuity50.0020.0070
Ke0.15
Kd9.00%
Tax Rate30%
DCF Values$333.333$317.460$650.79
Kwacc10.7561%
Entity Value$650.79
Cost of Capital Calculation: Market Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.48780.06300.0307
Equity0.51220.15000.0768
WACC10.76%
Cost of Capital Calculation: Book Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.52910.06300.0333
Equity (book)0.47090.15000.0706
WACC10.40%
Total Book Assets600.00
Firm Value673.28
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MVA-EVA Analysis
Tax Rate30%
EBIT100.00
Kwacc10.76%
Invested Capital600.00
NOPAT = EBIT(1-T)70.00
EVA = NOPAT - Kwacc x Invested Capital5.46
MVA = EVA / Kwacc50.79
Firm Value = MVA + Invested Capital650.79
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APV Analysis
Analysis of the Unlevered Cost of Equity:
Levered Equity Beta1.00
Debt Beta0.14
Levered Equity Value333.33
Debt Value317.46
Corporate tax rate30%
Cost of debt financing9%
Risk free rate8%
Market risk premium7%
Unlevered Beta0.66
Unlevered Cost of Equity12.60%
APV Estimate of Firm Value
Value of Unlevered Cash Flows555.56
Value of Interest Tax Savings95.24
Firm Value650.79
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In this analysis we evaluate the firm's unlevered beta using the following relationship:
(BeSe + BdD(1-T))/(Se + D(1-T)) = Bu
This relationship reflects the presence of corporate taxes and risky debt in the context of the CAPM.
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Compressed APVApproximation of firm valueInterest tax savings discounted using the unlevered cost of equity.
Inputs and FreeCashFlows
Givens:
Cost of debt, Kd9.00%Debt is perpetual
CAPEX10.00All cash flows are level perpetuals
Depreciation Expense10.00Current market rate of interest = the interest rate on debt.
Tax Rate30%Dividend payout = 100%
Beta coefficient1.00Levered Beta
Market risk premium7%
Risk free rate`8%
Balance Sheet
Assets600.00Cost of equity, Ke15%
Debt317.46
Equity282.54
Debt + Equity600.00
Income Statement
Revenues500.00
less: COGS(300.00)Calculation of Firm Free Cash Flow
Gross Profit200.00
less Operating Expense(100.00)EBIT100.00
EBIT100.00less: Taxes(30.00)
less: Interest(28.57)NOPAT70.00
EBT71.43plus: Depr.10.00
less: Taxes(21.43)less: CAPEX(10.00)
NI50.00Firm FCF70.00
Calculation of Equity Free Cash Flow
NI50.00
plus: Depreciation Expense10.00
less: CAPEX(10.00)
Equity Free Cash Flow50.00
or
EFCF50.00
plus: Int(1-T)20.00
Firm FCF70.00
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Finite
YearEquity Cash FlowDebt Cash FlowOperating Cash Flow
1998502070
1999543690
20005743100
20016169130
20026674140
20037080150
20047585160
Ke0.15
Kd0.09
Tax Rate0.3
DCF Values$247.94$305.91$553.84
Kwacc10.1947%
Entity Value$551.58
Exhibit 5.7
ROIC15.00%
growth (NOPLAT)6.00%
Investment Rate40.00%
Kwacc10.00%
Firm Value$1,118.61
NOPLATNet InvestmentFree Cash Flow
Year100
1106.0042.4063.60
2112.3644.9467.42
3119.1047.6471.46
4126.2550.5075.75
5133.8253.5380.29
6141.8556.7485.11
7150.3660.1590.22
8159.3863.7595.63
9168.9567.58101.37
10179.0871.63107.45
11189.8375.93113.90
12201.2280.49120.73
13213.2985.32127.98
14226.0990.44135.65
15239.6695.86143.79
16254.04101.61152.42
17269.28107.71161.57
18285.43114.17171.26
19302.56121.02181.54
20320.71128.29192.43
21339.96135.98203.97
22360.35144.14216.21
23381.97152.79229.18
24404.89161.96242.94
25429.19171.67257.51
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WACC and Valuation
Equity Cash FlowDebt Cash FlowOperating Cash Flow
Perpetuity50.0020.0070
Ke0.15
Kd9.00%
Tax Rate30%
DCF Values$333.333$317.460$650.79
Kwacc10.7561%
Entity Value$650.79
Cost of Capital Calculation: Market Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.48780.06300.0307
Equity0.51220.15000.0768
WACC10.76%
Cost of Capital Calculation: Book Values
Source of CapitalProportionAfter-tax CostProduct
Debt0.52910.06300.0333
Equity (book)0.47090.15000.0706
WACC10.40%
Total Book Assets600.00
Firm Value673.28
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MVA-EVA Analysis
Tax Rate30%
EBIT100.00
Kwacc10.76%
Invested Capital600.00
NOPAT = EBIT(1-T)70.00
EVA = NOPAT - Kwacc x Invested Capital5.46
MVA = EVA / Kwacc50.79
Firm Value = MVA + Invested Capital650.79
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APV Analysis
Analysis of the Unlevered Cost of Equity:
Levered Equity Beta1.00
Debt Beta0.14
Levered Equity Value333.33
Debt Value317.46
Corporate tax rate30%
Cost of debt financing9%
Risk free rate8%
Market risk premium7%
Unlevered Beta0.6571
Unlevered Cost of Equity12.60%
APV Estimate of Firm Value
Value of Unlevered Cash Flows555.56
Value of Interest Tax Savings95.24
Firm Value650.79
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In this analysis we evaluate the firm's unlevered beta using the following relationship:
(BeSe + BdD(1-T))/(Se + D(1-T)) = Bu
This relationship reflects the presence of corporate taxes and risky debt in the context of the CAPM.
Compressed APV
Analysis of the Unlevered Cost of Equity:
Levered Equity Beta1.00
Debt Beta0.14
Levered Equity Value333.33
Debt Value317.46
Corporate tax rate30%
Cost of debt financing9%
Risk free rate8%
Market risk premium7%
Unlevered Beta0.6571
Unlevered Cost of Equity12.60%
Compressed APV Estimate of Firm Value
Unlevered FCF$70.00
Interest tax savings8.57
Capitalized Cash Flow$78.57
Firm Value623.58
Value of Unlevered Cash Flows555.56
Value of Interest Tax Savings68.03
Firm Value623.58
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Sheet9
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Eskimo Pie CorporationBusiness valuation in practice
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Revised FCF1991
($ thousands)
1991
Explanation
Projected Net Income
$ 4,000
Revised estimate by Wheat First Securities of 1991 revenues found on page 5.
plus: After-tax interest expense
32
$52.5 (1 - .40) -- from Exhibit 6 for 1991.
NOPAT = NOI(1 - T)
4,032
NI + I(1 T)
Plus: Depreciation expense
1,400
Exhibit 2Depreciation expense for 1990 = $1,352
Less: Capital expenditures
(1,000)
Page 5estimate by Wheat First Securities
Less: Change in working capital
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Netting out cash NWC appears to decline with increasing sales.
Free cash flow (unadjusted)
$ 4,432
less: After-tax interest income
(396)
$13.191m x 5% x (1 - .40)one-time cash dividend.
Free cash flow (adjusted)
$ 4,036
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Cost of Capital EstimateKunlevered = risk-free rate + Betaunlevered(Market Risk Premium)Kunlevered = .0742 + 1.136 (.075) = .1594 or 15.94%
Book Value
Market
Total
Equity
Equity Value/
Asset
Company
of Equity
Value of Equity
Debt
Beta
Firm Value
Beta
Ben & Jerry's
26.3
110.1
2.8
1.2
0.98
1.170
Dreyer's Grand Ice Cream
113.1
534.0
44.3
1.4
0.92
1.293
Empire of Carolina, Inc.
45.1
51.4
89.8
0.3
0.36
0.109
Steve's Homemade Ice Cream
11.1
37.4
3.1
2.5
0.92
2.309
Hershey Foods Corp
1,335.3
4,002.5
282.9
1.0
0.93
0.934
Tootsie Roll Inds.
152.8
728.8
-
1.0
1.00
1.000
Average
1.2
0.85
1.136
-
Firm and Equity Value (Compressed APV Model)
-
Firm Value (DCF)Ignoring debt financing (all equity firm)
Value of Free Cash Flows (excluding excess cash)
Growth Rates in FCF
Discount Rates
0%
2%
4%
6%
8%
10%
12%
15%
26,905
31,665
38,156
47,532
62,266
88,787
150,669
16%
25,224
29,403
34,977
42,779
54,483
73,989
113,002
17%
23,740
27,443
32,286
38,890
48,429
63,419
90,401
FCF (1991)
$ 4,035.77
Excess Cash
$ 13,000.00
Total Value including excess cash
Growth Rates in FCF
Discount Rates
0%
2%
4%
6%
8%
10%
12%
15%
39,905
44,665
51,156
60,532
75,266
101,787
163,669
16%
38,224
42,403
47,977
55,779
67,483
86,989
126,002
17%
36,740
40,443
45,286
51,890
61,429
76,419
103,401
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Firm Value (Comparables)
Firm Value to
Equity Value
Firm Value
Company
Cash Flow
to Net Income
to Sales
Ben & Jerry's
16.85
29.76
1.16
Dreyer's Grand Ice Cream
24.00
33.58
1.63
Empire of Carolina, Inc.
8.40
5.84
0.58
Steve's Homemade Ice Cream
15.00
20.78
1.15
Hershey Foods Corp
14.66
18.23
1.48
Tootsie Roll Inds.
22.42
28.58
3.51
Average multiple (less max and min)
17.23
24.34
1.36
Estimate for Eskimo Pie--1991
4,432
4,000
61,000
Implied Firm Value
$ 76,373
$ 97,350
$ 82,737
Excess cash in 1991
$ 13,000
$ 13,000
$ 13,000
Total Value including excess cash
$ 89,373
$ 110,350
$ 95,737
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Preparation for BumbleBeeThe Compressed APV model.Cash flow estimation Estimating the unlevered cost of equity.Estimating the value of subsidized debt
-
Compressed APV Model and Equity Value
-
Cash flows
-
Estimating Unlevered Betas
Unlevered Cost of Equity
Comparable Company Information:
LeveredDebt toUnlevered
BetaEquityTax RateBeta
Campbell Soup0.700.130.380.65
Ralston Purina0.850.290.380.72
H.J. Heinz0.750.080.380.72
Average0.70
Risk - free rate10.37%
Market risk premium6.00%
Unlevered Cost of Equity14.55%
Notes:1. Beta(levered) = Beta(unlevered(1 + (D/E)(1-Tax Rate)). Note that E is market value = Bk Value Equity x Mkt/Book
2. Tax rate for competitors is assumed to be 38% but for Bumble Bee it is expected to be only 15% according to the proforma income statement found in Exhibit 8.
3. Note that I use the market value debt to equity ratio where market value equity = book value equity times the market to book ratio given in Exhibit 10.
Debt to market value equity ratio. Market value of equity = Book Equity x Mkt/Book Ratio.
Cash Flows
19861987198819891990199119921993
NOI (1-T) (Exhibit 8 & 15% tax rate)$12.4$13.2$13.5$14.3$16.2$16.2$16.2
Plus: depreciation (Exhibit 7)0.30.50.60.60.70.80.8
Less: CAPEX (Exhibit 7)(1.0)(1.0)(1.0)(1.0)(1.0)(1.0)(1.0)
Less: Additions to WC (Exhibit 7)(4.0)(0.3)0.82.3(9.4)0.0(2.4)
Firm Free Cash Flow$7.7$12.4$13.9$16.2$6.5$16.0$13.6
Tax Rate (Implied Exhibit 8 taxes)15%
Interest Expense (Exhibit 8)$8.4$5.2$7.6$6.6$5.4$4.5$2.5
Interest Tax Savings1.260.781.140.990.810.6750.375
Analysis of Growth Rate in Sales and Earnings
Projected Sales208.9211.9208.7209.5225.7225.7225.7
% Changes in Sales1.44%-1.51%0.38%7.73%0.00%0.00%
% Changes in NOI(1-T)6.16%2.58%5.66%13.10%0.00%0.00%
Analysis of Equity Free Cash Flows
($ millions)1986198719881989199019911992
Net Income (Exhibit 8)5.36.27.08.711.612.314.0
plus: Depreciation0.30.50.60.60.70.80.8
less: CAPEX(1.0)(1.0)(1.0)(1.0)(1.0)(1.0)(1.0)
less: Change in NWC(4.0)(0.3)0.82.3(9.4)0.0(2.4)
less: Debt principal repayments0.0(6.0)(6.0)(9.5)(5.5)(17.0)(10.0)
Equity Free Cash Flow0.6(0.6)1.41.1(3.6)(4.9)1.4
The tax shield for years 1993 and beyond is calculated as the difference in the value of the levered firm and unlevered firm in 1992. To calculate the value of the levered firm in 1992 we assume a constant debt/value ratio and use the Miles and Ezzel formula for the weighted average cost of capital. An alternative method is to assume a constant level of interest expense equal to 1992 interest expense ($.38), a tax rate of 15% and a cost of debt equal to the cost in 1992. This latter calculation results in a present value interest tax savings of only $.1241
The point of this analysis is to demonstrate that the presence of fixed costs (i.e., operating leverage) makes the growth rate in firm operating earnings different than the rate of growth in sales. In this instance, the year to year % changes in sales range from -1.51% to 7.73%. The corresponding range of growth in operating earnings is 2.58% to 13.1%.
Valuation
Growth in FCF beyond 19920.02
Borrowing Rate0.16
Estimation of Firm Value
PV of Unlevered FCFs
Planning period FCFs$50.39
Terminal Value FCFs$42.58
Value of Unlevered Firm$92.97
PV of Interest Tax Savings
Planning period$3.74
Terminal value$0.83
Value of Interest Tax Savings$4.57
Firm Value$97.54
Estimation of the Value of Subsidized Puerto Rican Debt Financing
Puerto Rican 936 Debt
Annuity payments based on 12%, $10 m principal, 5 year maturity$2.77
Present value of payments using 16% current market rate$9.08
Value of subsidy = $10 m - pv of payments at 16%$0.92
Castle Cooke Sub Debt at 12%$1.05
Total value of subsidized debt financing$1.96
Present value savings from subsidized financing
Firm Value + Debt Subsidy$98.45
Estimation of Equity Value
less: Debt value(59.20)
Equals: Equity value$39.25
Valuation Summary:
PV of Unlevered FCFs
Planning period FCFs50.39
Terminal Value FCFs42.58
Value of Unlevered Firm92.97
PV of Interest Tax Savings
Planning period3.74
Terminal value0.83Castle & Cooke Sub Debt
Value of Interest Tax Savings4.57YearPayments
0.51.50
PV of Subsidized Debt11.50
Section 936 Debt$0.921.52.00
Castle & Cooke Jr Sub Debt$1.0520.0
Total Value of subsidized debt$1.962.50.0
32.50
Firm Value99.503.50.0
less: Debt ($62.5m - $3.3m)(59.20)42.50
4.50.0
Equity Value40.3055.00
PV 12%$10.55
PV 16%$9.50
Difference$1.05
Debt value = total assets of $62.5 less equity of $3.3 which is the initial financing of the company.
Terminal value as of year end 1992 [FFCF(1992)(1+.02)/(.1455 - .02)]We discount this back 7 years using the unlevered cost of equity of 14.55%. Note the very conservative growth rate assumption for FFCF which is equal to the rate of growth in revenues for the tuna market.
Debt Amortization
Debt Amortization Schedule (millions)
198719881989199019911992
Senior Secured Bank Debt3.004.007.003.0012.0010.00
Senior Subordinated Notes
Junior Suborninated Notes3.002.002.502.505.00
Amortization of Debt6.006.009.505.5017.0010.00
For purposes of the valuation analysis we will assume that new debt will be issued in exactly the amounts of the
required principal payments of this debt, that is, the firm's debt financing remains constant after 1992.
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Valuing debt subsidiesExample5 year (interest only) loan with interest rate of 10% for a borrower that would otherwise have to pay 13%. In year 5 the borrower repays the $1,000 principal amount.
Dhahran
Edit the "blue" cells with appropriate Crystal Ball Pro formulas:
Stochastic Variables:
Pb of final receipt of retention pymtCustom distribution with payoffs of 0 and 1 and associated probabilities 0.10 and 0.90.
Total equipment costTriangular distribution with parameter values ($32 m, 38 m, 48 m).
Operating cost overrun %Normal with mean 0 and standard deviation .01. The correlation between year to year
cost overrun% is .70.
Retention payment factor1.00
Total equipment cost38,000,000
Beg. 1993End 1993End 1994End 1995End 1996End 1997End 1998Total
Billing$11,000,000$36,000,000$45,000,000$43,000,000$33,000,000$168,000,000
Advance$25,200,000$25,200,000
Advance Recovery (15%)$1,650,000$5,400,000$6,750,000$6,450,000$4,950,000$25,200,000
Retention (5%)$550,000$1,800,000$2,250,000$2,150,000$1,650,000$8,400,000
Retention repayment$4,200,000$4,200,000$8,400,000
Receipts$25,200,000$8,800,000$28,800,000$36,000,000$34,400,000$30,600,000$4,200,000$168,000,000
Equipment expenditures$28,500,000$9,500,000$38,000,000
Operating expense cost overrun factor0.00.00.00.00.0
Operating expenditures$7,000,000$25,000,000$29,000,000$27,000,000$20,000,000$108,000,000
Total Disbursements$28,500,000$16,500,000$25,000,000$29,000,000$27,000,000$20,000,000$146,000,000
Net Cash Flow$(3,300,000)$(7,700,000)$3,800,000$7,000,000$7,400,000$10,600,000$4,200,000$17,800,000
Hurdle Rate18%
NPV$7,170,101
IRR40.76%
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MWPetr(Alternative)
123456789101112131415
Production
(1) Net crude and condensates (MB)10.009.808.908.107.106.506.506.606.405.805.204.604.303.803.40
(2) Net gas (MMCF)50.2049.5043.7037.8031.8028.1026.2024.4021.6018.3015.9013.1011.8010.209.30
Price Forecast
Growth rate in crude prices6.00%
Crude20.3921.6122.9124.2825.7427.2928.9230.6632.5034.4536.5238.7141.0343.4946.10
Growth rate in gas prices8.00%
Gas2.002.162.332.522.722.943.173.433.704.004.324.665.045.445.87
Cash Flows (in millions)
(3) Revenues - oil203.90211.81203.90196.71182.77177.36188.00202.35207.99199.80189.88178.05176.42165.26156.74
(4) Revenues - gas100.40106.92101.9495.2386.5382.5883.1583.6379.9673.1668.6561.0959.4355.4854.63
(5) Total revenues304.30318.73305.84291.94269.29259.94271.16285.98287.95272.96258.53239.14235.85220.74211.37
(6) Direct production taxes27.5228.8227.6626.4024.3523.5124.5225.8626.0424.6823.3821.6321.3319.9619.11
(7) Direct operating expense88.6389.2788.7088.0887.0886.6687.1687.8287.9187.2486.6085.7485.5984.9284.50
(8) Overhead36.6038.7036.3033.6031.0028.8029.2029.3027.9026.3023.2021.4020.1019.1017.80
(9) Fin. Book DD&A71.4060.0049.6045.7037.0030.2031.6028.9023.0019.2018.0015.7013.8012.3011.00
(10) Net income before taxes80.15101.94103.5998.1689.8790.7798.68114.10123.11115.54107.3694.6795.0384.4678.95
(11) Federal and state income taxes:
(12) Current
(13) Deferred
(14) Total income taxes28.0735.7036.2834.3831.4731.7934.5639.9643.1240.4737.6033.1633.2829.5827.65
(15) Profit contribution52.0866.2467.3163.7858.3958.9864.1274.1479.9975.0769.7661.5261.7554.8851.30
(16) Non-cash charges47.6040.6033.8032.4027.7023.3023.6021.8018.1015.1014.3012.5011.3010.409.30
(17) Cash from operations99.68106.84101.1196.1886.0982.2887.7295.9498.0990.1784.0674.0273.0565.2860.60
(18) Capital expenditures42.6033.8041.8057.5034.109.401.902.602.003.9011.000.00.601.100.20
(19) Cash flow57.0873.0459.3138.6851.9972.8885.8293.3496.0986.2773.0674.0272.4564.1860.40
(20) Terminal Value464.619471534
Project ValuationPercent of Revenue Calculations
Unlevered cost of Equity13.00%(6) Direct production taxes9.04%of Revenues
Base case valuation(7) Direct operating expense26.87%of Revenues
Planning period cash flows$436.92(14) Total income taxes35.02%of taxable income
Terminal value$74.29
Base Case Value Estimate$511.21
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All % are based on year 1 projections from Exhibit 7.
RealOptions
Project revenues and investment cost
012345678910
Revenues$1.16$1.21$1.27$1.34$1.40$1.47$1.55$1.63$1.71$1.79
Initial Cost$(3.00)
Fuel Cost Analysis
Oil CostsProbabilities
High30%1.181.241.301.371.431.511.581.661.741.83
Normal40%0.790.830.870.910.961.011.061.111.171.23
Low30%0.390.410.430.450.470.500.520.550.580.61
Cost of Oil0.780.830.850.930.981.031.081.101.171.22
Cost of Gas1.001.001.001.001.001.001.001.001.001.00
Cost of Fuel0.780.830.850.930.981.001.001.001.001.00
Project Cash Flows
Cash Flows$(3.00)$0.38$0.38$0.42$0.41$0.42$0.47$0.55$0.63$0.71$0.79
Project Analysis
Cost of Capital10.00%
NPV($0.05)
IRR9.69%
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Project analysis of the Kulatilaka and Marcus (1992) flexible fuel power plant
Is this a good project? Why or why not?Is the analysis consistent with the "flexibility" in the project?Construct a simulation model that appropriately captures the value of the flexible plant.
HMGSimulation
Givens:
Investment4,000,000
Plant life5
Salvage value400,000
Variable Cost %45%
Fixed operating cost1,000,000
Tax rate38%
Working capital10%Change in revenues
Required Rate of Return15%
012345
Sales volume1,000,0001,500,0003,000,0003,500,0002,000,000
Unit Price2.002.002.502.502.50
Revenues2,000,0003,000,0007,500,0008,750,0005,000,000
Variable Operating Costs(900,000)(1,350,000)(3,375,000)(3,937,500)(2,250,000)
Fixed Operating Costs(1,000,000)(1,000,000)(1,000,000)(1,000,000)(1,000,000)
Depreciation Expense(800,000)(800,000)(800,000)(800,000)(800,000)
Net Operating Income(700,000)(150,000)2,325,0003,012,500950,000
less: Taxes266,00057,000(883,500)(1,144,750)(361,000)
NOPAT(434,000)(93,000)1,441,5001,867,750589,000
plus: Depreciation800,000800,000800,000800,000800,000
less: CAPEX(4,000,000)0.00.00.00.0248,000
less: Working Capital(200,000)(100,000)(450,000)(125,000)375,000500,000
Free Cash Flow(4,200,000)266,000257,0002,116,5003,042,7502,137,000
NPV419,435
IRR18.01%
Random Variables
Sales Volume (error)00000
Sales Price (error)11111
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Sales(t+1) Error = normal(0,200000) where correlation[Sales(t+1),Sales(t)] = .50
Price(t+1) Error Factor = lognormal(1,.1) where correlation [Error Factor (t+1),Error Factor (t)] = .80
DebtSubsidy
Subsidized interest rate10%
Market rate13%
Principal amount$1,000.00
Maturity (years)5
Principal and InterestYear
$100.001
$100.002
$100.003
$100.004
$1,100.005
Value of Note (10%)$1,000.00
Value of Note (13%)$894.48
Value of Subsidy$105.52
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What have we learned?There are multiple DCF models of firm value.The APV model offers significant advantages over alternative methods in some applications but is not the standard DCF model (yet).Subsidized financing is valuable and the value can be quantified.Unlevering beta coefficients can be very confusing.
****Comments:This diagram characterizes three separate but equivalent ways of performing a discounted cash flow analysis of the value of a business firm. Our objective in todays lecture is to move rather quickly through the first two methods to the third (APV) that will be used in your analysis of the MW Petroleum case for next class.Note that there are two fundamental elements involved in DCF valuationa cash flow definition and an appropriate discount rate.**Comments:The first method we consider (Method A in your lecture note on Basic, Inc. that is attached to the assignment sheet on the class web page).This method is commonly referred to as either the component method or flow through to equity method. It is the component method as we value the firm by valuing each of the component securities it has issued and summing those values. Flow through to equity is used for the method entails valuing the firms equity directly based on the cash flows that flow through to the common shareholders.*Comments:Note that EFCF represents the cash that could be distributed to the firms stockholders without impairing the firms ability to take advantage of new investment opportunities. Note, too, that the firm can borrow money that can, in turn, be used to distribute cash to shareholders (assuming there are no restrictions or covenants that forbid such payments). When a firm does this it sometimes repurchases its own common shares in which case this transaction is referred to as a leveraged recapitalization.****Comment: this is the approach taken in your Entrepreneurial Finance class.*Comments:Note that with the Entity Method we are valuing the enterprise of firm as a whole so our cash flow must include all the cash available to pay to all classes of security holders (debt and equity). Thus, interest expense (which is part of the payment made to the firms creditors) is not deducted.Transition:The next slide details the exact nature of the FFCF calculation. *Fundamental Point:The Free Cash Flow calculation we made in the previous slide is equivalent to summing up the payments made to each of the firms claimants (net of new financing raised during the period). That is, the firms free cash flow is simply the total amount of funds paid to its sources of financing for the period (after tax).Thus when we discount FFCF we are simply discounting the sum of the after tax payments being made to the firms financial claimants for each period. See T. Copeland, T. Koller, and J. Murrin, 1994, Valuation: Measuring and managing the value of companies, John Wiley), p. 136.Transition:Lets now calculate free cash flow for the Basic Inc. example.**Comments:The key point to make here is that the financing proportions are based on market values of equity, debt and the firm. For example, the proportion of equity financing equals $333.33/650.77 = .5122. Contrast this with the proportion of equity where book values are used, i.e.,Equity proportion (book) = ($600 - 317.44)/600 = .470933Had we used book values to calculate the WACC the result would have been as follows:
Cost of Capital Calculation: Book ValuesSource of CapitalProportion After-tax CostProductDebt 0.5291 0.0630 0.0333 Equity (book) 0.4709 0.1500 0.0706 10.40%Total Book Assets 600.00 Firm Value 673.27
Transition:As we see on the next slide, the cost of capital is higher than 10.40% and consequently the value of the firm is lower than $673.27.**Comments:EVA is a measure of a firms contribution to value for a single period. Although the concept has been around for years it has recently been popularized by Stern Stewart & Co.Although the measure does have some serious shortcomings, it has been used very effectively by a number of firms to improve firm performance.*Comments:The last approach to firm valuation is the APV method.We will use this model in valuing Bumble Bee Tuna and MW Petroleum in subsequent classes. *Comments:How does the use of debt financing impact your estimate of firm value using the APV model?Whats missing here?*CommentsYup!, thats right. They are the same thing.*****Comments:Note that we unlever the comparable company betas and use the unlevered beta to estimate Eskimos cost of capital. This is appropriate only where Eskimo has no financial leverage (and this is approximately true).We use a very simple delevering formula that ignores the presence of taxes and the possibility that debt is risky.Specifically, the delevering formula is based on the following relationship:Beta(unlevered equity) = Beta(debt)(D/V) + Beta(Levered Equity)(E/V)Which reduces to the following expression where debt has a beta of zero and there are no taxes:Beta(unlevered equity) = Beta(Levered Equity)(E/V)*Comments:Note that interest tax savings are assumed to equal the full corporate tax rate times interest expense.Interest tax savings are assumed to grow at the same rate as the firms FCF.Capitalized Cash Flow = FCF + Interest tax savings**Comments:These results suggest that the Nestle offer may be too low.Note that the first and third columns provide estimates of the value of the entire firm while column two offers a value estimate for the firms equity. However, Eskimo uses only $744 in debt as of the end of 1990. The average multiples are based on an average of the set of comparables after throwing out the lowest and highest multiple. *Comments:This case involves the valuation of a management buyout of the Bumble Bee Tuna division of Castle Cook. The analysis entails use of the APV methodology as the capital structure for the buyout varies greatly over the first several years as the firm pays down the buyout debt. The buyout also includes some subsidized debt financing (I.e., below market rate loans) whose value must be estimated.Finally, we must estimate the unlevered cost of equity.Cash flow estimates are provided in the documentation of the case.*Comments:The CAPV differs from the standard version of the APV model only in that it uses the unlevered cost of equity for the firm to evaluate the present value of the interest tax savings.Technically, the liabilities total should only include interest bearing debt since only interest bearing debt is considered in the valuation of the firm as a whole.Note that you will be discounting cash flows for a planning period and adding a terminal value to get the value of the firms capitalized cash flows.You will encounter subsidized financing in the case and will need to estimate the value of the subsidy.*Comments:This slide illustrates the calculation of firm free cash flows (recall that this is the same as the cash flow to the unlevered firms equity), and the calculation of interest tax savings.*Comments:This particular relationship for the levered and unlevered beta corresponds to the situation where debt has a beta of zero and the firm pays corporate taxes on its income. The final equation captures the full relationship between the unlevered or firm beta and the betas of the firms equity and debt.
*Questions:What is the value of the subsidy on this loan where the market rate of interest is 15%?Where have you observed subsidized loans in your business or personal life?*