Question

You have been hired as a consultant to ABC company that is seeking to increase its value. ABC has asked you to estimate the value of two privately held companies that ABC is considering acquiring. But first, the senior management of ABC would like for you to explain how to value companies that don't pay any dividends. You have structured your presentation around the following questions.

1. List the two types of assets that companies own.    

2. What are assets-in-place? How can their value be estimated?

3. What are non-operating assets? How can their value be estimated?

4. What is the total value of a corporation? Who has claims on this value?

5. The first acquisition target is a privately held company in a mature industry. The company currently has free cash flow of $20 million. Its WACC is 10% and it is expected to grow at a constant rate of 5%. The company has marketable securities of $100 million. It is financed with $200 million of debt, $50 million of preferred stock, and $210 million of book equity.

The second acquisition target is a privately held company in a growing industry. The target has recently borrowed $40 million to finance its expansion; it has no other debt or preferred stock. It pays no dividends and currently has no marketable securities. ABC expects the company to produce free cash flows of -$5 million in one year, $10 million in two years, and $20 million in three years. After three years, free cash flow will grow at a rate of 6%. Its WACC is 10% and it currently has 10 million shares of stock.

FOR EACH CO.:

a. What is its total corporate value? What is its value of equity?

b. What is its value of operations?

c. What is its MVA (MVA = Total corporate value – Total book value)?

d. What is its terminal (horizon value)? What is its current value of operations (i.e., at time zero)?

e. What is its value of equity on a price per share basis?

9. What is expected return on invested capital (EROIC)?Why is the spread between EROIC and WACC so important?What is the EVA?

10. ABC has two divisions. Both have current sales of $1,000, current expected growth of 5%, and a WACC of 10%. Division A has high profitability (OP=6%) but high capital requirements (CR=78%). Division B has low operating profitability (OP=4%) but low capital requirements (CR=27%). What is the MVA of each division, based on the current growth of 5%? What is the MVA of each division if growth is 6%?

11. What is the EROIC of each division for 5% growth and for 6% growth? How is this related to MVA?