The Corporate Valuation Model 441
We see, then, that for most companies operating assets are far more important than
nonoperating assets. Moreover, companies can influence the values of their operating
assets, but the values of nonoperating assets are largely out of their direct control.
Therefore, value-based management, hence this chapter, focuses on operating assets.
Estimating the Value of Operations
Tables 12-1 and 12-2 contain the actual 2002 and projected 2003 to 2006 financial
statements for MagnaVision Inc., which produces optical systems for use in medical
photography. (See Chapter 11 for more details on how to project financial state-
ments.) Growth has been rapid in the past, but the market is becoming saturated, so
the sales growth rate is expected to decline from 21 percent in 2003 to a sustainable
rate of 5 percent in 2006 and beyond. Profit margins are expected to improve as the
production process becomes more efficient and because MagnaVision will no longer
be incurring marketing costs associated with the introduction of a major product. All
items on the financial statements are projected to grow at a 5 percent rate after 2006.
Note that the company does not pay a dividend, but it is expected to start paying out
about 75 percent of its earnings beginning in 2005. (Chapter 14 explains in more de-
tail how companies decide how much to pay out in dividends.)
Recall that free cash flow (FCF) is the cash from operations that is actually avail-
able for distribution to investors, including stockholders, bondholders, and preferred
stockholders. The value of operations is the present value of the free cash flows the
firm is expected to generate out into the future. Therefore, MagnaVision’s value can
be calculated as the present value of its expected future free cash flows from opera-
tions, discounted at its weighted average cost of capital, WACC, plus the value of its
TABLE 12-1 MagnaVision Inc.: Income Statements
(Millions of Dollars Except for Per Share Data)
Actual Projected
2002 2003 2004 b 2005 2006
Net sales $700.0 $850.0 $1,000.0 $1,100.0 $1,155.0
Costs (except depreciation) $599.0 $734.0 $ 911.0 $ 935.0 $ 982.0
Depreciation 28.0 31.0 34.0 36.0 38.0
Total operating costs $627.0 $765.0 $ 945.0 $ 971.0 $1,020.0
Earnings before interest and taxes (EBIT) $ 73.0 $ 85.0 $ 55.0 $ 129.0 $ 135.0
Less: Net interesta 13.0 15.0 16.0 17.0 19.0
Earnings before taxes $ 60.0 $ 70.0 $ 39.0 $ 112.0 $ 116.0
Taxes (40%) 24.0 28.0 15.6 44.8 46.4
Net income before preferred dividends $ 36.0 $ 42.0 $ 23.4 $ 67.2 $ 69.6
Preferred dividends 6.0 7.0 7.4 8.0 8.3
Net income available for common dividends $ 30.0 $ 35.0 $ 16.0 $ 59.2 $ 61.3
Common dividends — — — $ 44.2 $ 45.3
Addition to retained earnings $ 30.0 $ 35.0 $ 16.0 $ 15.0 $ 16.0
Number of shares 100 100 100 100 100
Dividends per share — — — $0.442 $0.453
Notes:a
“Net interest” is interest paid on debt less interest earned on marketable securities. Both items could be shown separately on the income statements,
but for this example we combine them and show net interest. MagnaVision pays more interest than it earns, hence its net interesb t is subtracted.
Net income is projected to decline in 2004. This is due to the projected cost for a one-time marketing program in that year.
See Ch 12 Tool Kit.xlsfor
details.
438 Corporate Valuation, Value-Based Management, and Corporate Governance
