Valuing Companies in Corporate Restructuring, Technical Note Harvard Business School Case #910-410 201073 Case Software #XLS-825

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Exhibit 2 Adjusted Present Value (APV) Method: Constant Debt Level

Note: Assume that the firm maintains its debt at a constant dollar level over time. Initial debt Initial net operating loss carryforwards (NOLs) Expected rate of return on debt (Rd) Expected rate of return on equity (Re), initial valuea Asset beta (Ba) Long-term U.S. government bond rate (Rf) Market risk premium (Rm-Rf) Expected rate of return on assets (Ra), where Ra = Rf + Ba(Rm-Rf) Long-term annual growth rate (g) Marginal corporate tax rate Panel A. Free cash flows generated by the business Line # 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Year 1 2 3 800.0 860.0 925.0 (720.0) (774.0) (786.3) (48.0) (51.6) (50.9) 32.0 34.4 87.9 (24.0) (24.0) (24.0) 8.0 10.4 63.9 (2.7) (3.5) (21.7) 5.3 6.9 42.2 21.1 22.7 58.0 90.0 93.0 98.0 (95.0) (96.0) (105.0) (16.0) (17.2) (18.5) 8.0 0.0 0.0 3.0 1.0 0.0 11.1 3.5 32.5 100.3 515.0 615.3 4 5 950.0 1,020.0 (807.5) (816.0) (52.3) (40.8) 90.3 163.2 (24.0) (24.0) 66.3 139.2 (22.5) (47.3) 43.7 91.9 59.6 107.7 105.0 112.0 (115.0) (120.0) (19.0) (20.4) 0.0 0.0 0.0 0.0 30.6 79.3 907.7 300 140 8.0% 14.8% 0.8 6.0% 7.5% 12.0% 3.0% 34.0%

Revenues Cost of goods sold Selling, general and administrative expenses EBIT Interest expense Profit before tax Taxes (@34%) Net income EBIAT + Depreciation - Capital expenditures - Investment in net working capital + Excess cash + Proceeds from asset sales Free cash flows Terminal value b Present value of year 1 -5 cash flows Present value of terminal value Total present value (discounted at Ra)

Based on the firm's initial enterprise value of 748.7. Over time, Re is expected to decline due to forecasted increases in the firm's enterprise value, which will reduce its financial leverage (= debt / enterprise value). In panel III, the present value of cash flows from using NOLs is calculated using a different estimate of Re each year, based on updated estimates of the firm's enterprise value and financial leverage. Re is estimated using the capital asset pricing model: Re = Rf + Be*(Rm-Rf). Be, the beta of the firm's equity, is derived from the relationship: Ba = (D/V)*Bd + (E/V)*Be, where V denotes enterprise value, and Bd is assumed to equal 0.25 (see Cornell and Green (1991)).

b Valued using the growth perpetuity formula: Terminal year cash flow * (1+g)/(Ra-g)

Exhibit 2 (continued) Adjusted Present Value (APV) Method: Constant Debt Level Note: Assume that the firm maintains its debt at a constant dollar level over time. Panel B. Cash flows from interest tax shields Year 3 300.0 300.0 24.0 24.0 8.2 8.2

Line # 20 21 22 23 24 25 26

Debt Interest expense Tax savings (@34% tax rate) Terminal value3 Present value of year 1 -5 cash flows Present value of terminal value Total present value (discounted at Rd)
a

1 300.0 24.0 8.2 32.6 69.4 102.0

4 300.0 24.0 8.2

5 300.0 24.0 8.2 102.0

Valued using simple perpetuity formula: Terminal year cash flow/ Rd

Panel C. Cash flows from using net operating loss carryforwards (NOLs) Year 3 63.9 63.9 82.3 21.7

Line # 27 28 29 30 31

Profit before tax NOLs used Cumulative NOLs used Reduction in taxes paida Total present value (discounted at Re)
a

1 8.0 8.0 8.0 2.7 31.4

2 10.4 10.4 18.4 3.5

4 66.3 57.7 140.0 19.6

5 139.2 0.0 140.0 0.0

Equals NOLs used each year x the marginal corporate tax rate (34%)

Panel D. Total enterprise value Present value 615.3 102.0 31.4 748.7

Source of cash flow Free cash flows generated by the business Cash flows from interest tax shields Cash flows from using net operating loss carryforwards (NOLs) Total

Exhibit 3 Adjusted Present Value (APV) Method: Declining Debt Level Note: Assume that the firm uses all available net cash flows (= free cash flows - after-tax interest expense) to pay down debt each year through year 5, then maintains debt at a constant level thereafter. Initial debt Initial net operating loss carryforwards (NOLs) Expected rate of return on debt (Rd) Expected rate of return on equity (Re), initial valuea Asset beta (Ba) Long-term U.S. government bond rate (Rf) Market risk premium (Rm-Rf) Expected rate of return on assets (Ra), where Ra = Rf + Ba(Rm-Rf) Long-term annual growth rate (g) Marginal corporate tax rate Panel A. Pro forma debt projection Year 1 2 3 4 32.0 34.4 87.9 90.3 (24.1) (24.5) (23.4) (20.3) 7.9 9.9 64.5 69.9 0.0 0.0 0.0 (4.2) 7.9 9.9 64.5 65.8 90.0 93.0 98.0 105.0 (95.0) (96.0) (105.0) (115.0) (16.0) (17.2) (18.5) (19.0) 8.0 0.0 0.0 0.0 3.0 1.0 0.0 0.0 (2.1) (9.3) 39.0 36.8 300.0 302.1 311.4 272.4 302.1 311.4 272.4 235.6 300 140 8.0% 14.8% 0.8 6.0% 7.5% 12.0% 3.0% 34.0%

Line # 1 2 3 4 5 6 7 8 9 10 11 12 13
a

EBIT Interest expense Profit before tax Taxes (@34%)b Net income + Depreciation - Capital expenditures - Investment in net working capital + Excess cash + Proceeds from asset sales Net cash flow Beginning of year debt End of year debt

5 163.2 (16.1) 147.1 (50.0) 97.1 112.0 (120.0) (20.4) 0.0 0.0 68.7 235.6 166.9

Based on the firm's initial enterprise value of 723.2. Over time, Re is expected to decline due to forecasted increases in the firm's enterprise value and forecasted reduction in its debt, which will reduce its financial leverage (= debt / enterprise value). In panel III, the present value of cash flows from using NOLs is calculated using a different estimate of Re each year, based on updated estimates of the firm's enterprise value and financial leverage. Re is estimated using the capital asset pricing model: Re = Rf + Be*(Rm-Rf). Be, the beta of the firm's equity, is derived from the relationship:Ba = (D/V)*Bd + (E/V)*Be, where V denotes enterprise value, and Bd is assumed to equal 0.25 (see Cornell and Green (1991)).
b

Reflects utilization of net operating loss carryforwards (NOLs)

Exhibit 3 (continued) Adjusted Present Value (APV) Method: Declining Debt Level Note: Assume that the firm uses all available net cash flows (= free cash flows - after-tax interest expense) to pay down debt each year through year 5, then maintains debt at a constant level thereafter. Panel B. Cash flows from interest tax shields Year 2 3 311.4 272.4 24.5 23.4 8.3 7.9

Line # 20 21 22 23 24 25 26

Debt Interest expensea Tax savings (@34% tax rate) Terminal valueb Present value of year 1 -5 cash flows Present value of terminal value Total present value (discounted at Rd)
a b

1 302.1 24.1 8.2 29.8 46.6 76.4

4 235.6 20.3 6.9

5 166.9 16.1 5.5 68.4

Interest expense is based on the average amount of debt outstanding during the year Valued using simple perpetuity formula: Terminal year cash flow / Rd

Panel C. Cash flows from using net operating loss carryforwards (NOLs) Year Line # 27 28 29 30 31 Profit before tax NOLs used Cumulative NOLs used Reduction in taxes paida Total present value (discounted at Re)
a

1 7.9 7.9 7.9 2.7 31.5

2 9.9 9.9 17.8 3.4

3 64.5 64.5 82.3 21.9

4 69.9 57.7 140.0 19.6

5 147.1 0.0 140.0 0.0

Equals NOLs used each year x the marginal corporate tax rate (34%)

Panel D. Total enterprise value Source of cash flow Free cash flows generated by the business (from exhibit 1) Cash flows from interest tax shields Cash flows from using net operating loss carryforwards (NOLs) Total Present value 615.3 76.4 31.5 723.2

Exhibit 4 Capital Cash Flow (CCF) Method Note: Assume that the firm uses all available net cash flows (= free cash flows - after-tax interest expense) to pay down debt each year through year 5, and thereafter grows debt at the same rate as total capital cash flows (and total enterprise value). Initial debt Initial net operating loss carryforwards (NOLs) Expected rate of return on assets (Ra) Long-term annual growth rate (g) Marginal corporate tax rate Panel A. Net income version Year 1 2 3 4 5 7.9 9.9 64.5 65.8 97.1 90.0 93.0 98.0 105.0 112.0 (95.0) (96.0) (105.0) (115.0) (120.0) (16.0) (17.2) (18.5) (19.0) (20.4) 8.0 0.0 0.0 0.0 0.0 3.0 1.0 0.0 0.0 0.0 24.1 24.5 23.4 20.3 16.1 22.0 15.2 62.4 57.1 84.8 970.3 160.6 550.6 711.1 300 140 12.0% 3.0% 34.0%

Line # 1 2 3 4 5 6 7 8 9 10 11 12

Net incomea + Depreciation - Capital expenditures - Investment in net working capital + Excess cash + Proceeds from asset sales + Interest expense Capital cash flows Terminal valueb Present value of year 1 -5 cash flows Present value of terminal value Total present value (discounted at Ra) Panel B. EBIT version

Line # 13 14 15 16 17 18 19 20 21 22 23 24 25
a b

EBIT Taxes (@ 34%)a EBIAT + Depreciation - Capital expenditures - Investment in net working capital + Excess cash + Proceeds from asset sales Capital cash flows Terminal valueb Present value of year 1 -5 cash flows Present value of terminal value Total present value (discounted at Ra)

Year 1 2 3 4 5 32.0 34.4 87.9 90.3 163.2 0.0 0.0 0.0 (4.2) (50.0) 32.0 34.4 87.9 86.1 113.2 90.0 93.0 98.0 105.0 112.0 (95.0) (96.0) (105.0) (115.0) (120.0) (16.0) (17.2) (18.5) (19.0) (20.4) 8.0 0.0 0.0 0.0 0.0 3.0 1.0 0.0 0.0 0.0 22.0 15.2 62.4 57.1 84.8 970.3 160.6 550.6 711.1

Reflects utilization of net operating loss carryforwards (NOLs)

Valued using growth perpetuity formula: Terminal year cash flow * (1 +g)/(Ra-g)

Exhibit 5 Valuation Using Comparable Company Multiples Estimate of Allied Industries' enterprise value using Enterprise Value/EBIT multiple derived from comparable companies A, B, and C. Enterprise Five Year Value / Year CAGR in Enterprise Value 1 EBIT EBIT 5 163.2 546.4 64.4 63.1 38.5% 8.3% 6.1% 19.6%

Allied Industries Company A Company B Company C

1 32.0 366.0 48.0 25.8

EBIT in Year: 2 3 4 34.4 87.9 90.3 398.2 423.8 484.7 48.3 55.0 55.3 25.9 49.6 56.2

3,581.5 783.7 321.2

9.8 16.3 12.4 12.9 32.0 412.8 711.1

Average (Enterprise Value/EBIT) multiple of comparable companies Allied Industries' forecasted Year 1 EBIT Estimated enterprise value using comparable company multiple Estimated enterprise value using discounted cash flow method (exhibit 4)