Corporate Finance

Juan Carlos Ganme

Gerardo Fumagal

Osvaldo Gallegos

Cases: Marriott A and Flinder Valves

 Case Marriott A

Questions to solve:

1. Why is Marriott’s CFO proposing the Project Chariot?

To improve the financial performance of the firm, by re-structuring the company in two
separating activities to distinguish those that require a large fixed assets (Real estates
ownership) and those with relative low amount of assets (Management services and
others).

By dividing in this way, the large amount of debt will go with the real estates ownership
called Host Marriott Corp. (HMC), whereas the rest of activities will go to Marriott
International (MII). Doing so, the value of the 2 firms combined will exceed this year’s
book value, according to expectations (see appendix 1).

2. Is the proposed restructuring consistent with management’s responsibilities?

It is, as it clearly separate the activities and focus on management services rather than
owning the hotels. Furthermore, it improves the cash flows from the existing structure
(see appendix 1), this improvement will allow HMC to meet its debt responsibilities ( a
total cash flow projected of $771 million in 1992 versus $478 million in 1991.

The DCF in HMC assuming a worst case scenario will exceed current value of the firm’s
assets $5,218 million versus $4,600 million, which indicates that the firm will improve as
its assets will appreciate.

3. The case describes two conceptions of managers’ fiduciary duty (page 9).
Which do you favor: the shareholder conception or the corporate
conception? Does your stance make a difference in this case?

We agree upon favoring the shareholder conception, as this provides an improvement on

cash flows, as this condition is met, other financial gaps can be covered, plus it revalues
the total firm based upon the expected cash flows.

In this particular case, by having this improvement on cash flow, debt responsibilities can
be covered inside HMC or by using the line of credit guaranteed by MII.

On regards of the bondholders, the option is to increase the return as bonds will reduce
the grade to junk bonds, for the calculation on DCF we assume a return of 10.81
assuming the highest risk for bonds. This action will compensate bondholders for the
action.

4. Should Mr. Marriott recommend the proposed restructuring to the board?

Yes, as it increase the value of the combined firms, focus activities per company and
provides better cash flows.
 Appendix 1.

Marriott A Forecast
1989 1990 1991 1992 Notes

MC

Long-term debt D 3598 2979

Total shareholder's equity E 407 679

Book Value 4005 3658

Sales 7,536 7,646 8,331

Growth 14% 1% 9%
Share Price 33.38 10.50 16.50
EPS 1.62 0.46 0.80
Dividends 0.25 0.28 0.28
Ke 10.70% Using the dividend formula
Kd 9.30% (DIV/Po)+g
WACC 8.01%

HMC

Long-term debt D 2,000

Total shareholder's equity E 600
Sales 1,800
Operating cash flow before corporate expenses, interest 363
expenses and taxes
Total Assests 4,600
Ke 10.70%
Kd 10.81%
WACC 7.96%
DCF 5,218 Assuming the worst case
scenario growth as in 1990

Book Value 2600

MIC

Long-term debt D 400

Total shareholder's equity E 800
Sales 7900
Operating cash flow before corporate expenses, interest 408
expenses and taxes

Book Value 1200

Combined Value 3800

 Case Flinder Valves and Controls

Questions to solve:

5. How do you see FVC’s situation? What are the strengths and weaknesses of
FVC and RSE? Why should the two companies want to negotiate?

FVC is about to embark in a project with high risk, that involves a technology not yet
probed to be deployed. Its financial structure is based on pure equity to finance its
operations. The ratio analysis shown that the margins of FVC are quite lower in
comparison with those from RSE, 74 % in average fro FVC and 28 % in average for
RSE. This represents and advantage for FVC in case of the merger, as more cash can fund
their projects especially in the case of high risk is associated.

FVC has appreciate on its stock value on the last 3 year growing from 22.25 to 39.75
increasing the equity of the company, this is an advantage for RSE to make the merger,
RSE has sustained its stock value on the last years, so the opportunity to buy FVC is to
improve its stock value.

RSE has a capital structure balanced between debt and equity, more flexible that FVC a
14 % debt from capital is presented in 2007. RSE WACC is on 24.4 % and tends to lower
as prediction on stock price will improve the value lowering the cost of equity since
dividend will remain.

The companies should merge, as benefits to promote project are clear, their numbers will
improve WACC is lower and cash will increase to fund the high risk projects.

6. What is FVC worth? What are the key value drivers?

FVC value according to DFC method worth 75 million, although, by using the industry’s
average the value seems to be higher more than 103 million which is closer to the market
capitalization given in the case. The difference can be explain by the capital structure of
the firm as it does not have debt the WACC is higher so is the discount rate, with more
debt the discount is lower the value will increase.

FVC is a firm based on high skilled engineers that develop contractual work for
machinery industry; FVC strives for innovation and technology. We do not know about
the cycle of product development on this industry but that has to be a driver in order to
decide the capital structure
 Appendix 2.

FVC
2007 2008 2009 2010 2011 2012

DCF Value
WACC 3.3%
=EBIT*(1-Tc)+Depreciation
CFA exp - ΔWCR - Net capital exp $1,580 $5,310 $5,784 $6,428 $7,249
$
Residual value of assets 51,414
DCF value of =NPV(WACC,CFAi)+residual
assets value of assets $75,004

Value of
Assets

By comparables:

Price-earnings ratio Average of Industry 18.55

Estimated value =EAT*PE ratio $103,416

FVC
Ratios

ROE =EAT/Equity 15%

RSM

ROE =EAT/Equity 17%

Debt % 14% 14%

Ke 18.9% 7.2%

Kd 7.76% 6.98%

WACC 24.24% 9.59%