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company that is seeking to increase its value. KFS has asked you to
estimate the value of two privately held companies that KFS is
considering acquiring. But first, the senior management of KFS 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.
24 (1+0.05)
( 011.−005)
Vop =420
MVA = total corporate value of firm minus total book value of firm
total book value of firm = book value of equity + book value of debt
+ book value of preferred stock
$ -4.545
8.264
15.026
398.197
$416.942 = Value of operations
h. What are the four value drivers? How does each of them affect
value?
MVA is determined by four drivers: sales growth, operating profitability
(OP=NOPAT/sales), capital requirements (CR=operating capital / sales, and the
weighted average cost of capital. MVA will improve if WACC is reduced,
operating profitability (OP) increases, or the capital requirement (CR) decreases.
See the next question for an explanation of the impact of growth.
EROIC is the return on the capital that is in place at the beginning of the period:
EROICt = NOPATt+1
Capitalt
If the spread between the expected return, ROICt, and the required return, WACC, is positive, then
MVA is positive and growth makes MVA larger. The opposite is true if the spread is negative.
j. KFS 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 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%?
Division A Division B
OP 6% 6% 4% 4%
CR 78% 78% 27% 27%
Growth 5% 6% 5% 6%
MVA (300.0)(360.0) 300.0 385.0
k. What is the ROIC of each division for 5% growth and for 6% growth?
How is this related to MVA?
Division A Division B
Capital0 $780 $780 $270 $270
Growth 5% 6% 5% 6%
Sales1 $1,050 $1,060 $1,050 $1,060
Nopat1 $63 $63.6 $42 $42.4
Roic1 8.1% 8.2% 15.6% 15.7%
Mva (300.0) (360.0) 300.0 385.0
The expected ROIC of division A is less than the WACC, so the division should postpone growth
efforts until it improves ROIC by reducing capital requirements and/or improving profitability.
The expected ROIC of division b is greater than the WACC, so the division should continue with its
growth plans.
l. List six potential managerial behaviors that can harm a firm’s value.
Managers might:
1. Expend too little time and effort.
2. Consume too many nonpecuniary benefits.
3. Avoid difficult decisions out of loyalty to friends in company.
4. Reject risky positive NPV projects to avoid looking bad if project fails; take on risky negative
NPV projects to try and hit a home run.
5. Avoid returning capital to investors by making excess investments in marketable securities or by
paying too much for acquisitions.
6. Massage information releases or manage earnings to avoid revealing bad news.
Corporate governance is the set of laws, rules, and procedures that influence a company’s operations
and the decisions made by its managers.
The provisions under a firm’s control are:
(2) Charter provisions and bylaws that affect the likelihood of hostile takeovers.
(1) The CEO is not also the chairman of the board and does not have undue
influence over the nominating committee.
(2) The board has a majority of true outsiders who bring some type of business
expertise to the board (and he board is not an interlocked board)
The owner of stock options has the right to buy a share of the company’s stock at a specified price
even if the actual stock price is higher. Usually these options can’t be exercised for several years.
Manager can underperform market or peer group, yet still reap rewards from options as long as the
stock price increases to above the exercise cost. Options sometimes encourage managers to falsify
financial statements or take excessive risks.
Companies in countries with strong protection for investors tend to have better
access to financial markets, a lower cost of equity, increased in market liquidity,
and less noise in stock prices.