Including cashin the picture (whichwe almost always do
withreturnonequityandsometimeswithreturnoncapital)
just muddies the waters.
ILLUSTRATION 10.1: Consolidated versus Separate
Valuation: All-Equity Firm
To examine the effects of a cash balance on firm value,
considerafirmwithinvestmentsof$1,000millioninnoncash
operatingassetsand$200millionincash.Forsimplicity,let
us assume the following.
- Thenoncashoperatingassetshaveabetaof 1 andare
expected to earn$120 million in netincome each
year in perpetuity, and there are no reinvestment
needs (to match the assumption of no growth). - Thecash isinvestedattheriskless rate,which we
assume to be 4.5%. - Thenetincomeisreturnedtostockholderseveryyear
(as dividends or buybacks). - The market risk premium is assumed to be 5.5%.
- The firm is all equity funded.
Undertheseconditions,wecanvaluetheequity,usingboth
the consolidated and separate approaches.
Let us first consider the consolidated approach. Here, we
estimateacostofequityforalloftheassets(includingcash)
by computing a weighted average beta of the noncash
operatingandcashassets,usingtheestimatedvaluesofeach
as weights (see below for estimated value of operating assets).