448 CHAPTER 12 Corporate Valuation, Value-Based Management, and Corporate Governance
The Memory Division produces memory chips for such handheld electronic de-
vices as cellular phones and PDAs (personal digital assistants), while the Instruments
Division produces devices for measuring and controlling sewage and water treatment
facilities. Table 12-5 shows the latest financial results for the two divisions and for the
company as a whole.
As Table 12-5 shows, Bell Memory is the larger of the two divisions, with higher
sales and more operating capital. Bell Memory is also more profitable, with a
NOPAT/Sales ratio of 7.9 percent versus 7.2 percent for Bell Instruments. This year,
as in other recent years, the focus of the initial strategic planning sessions was on the
Memory division. Bell Memory has grown rapidly because of the phenomenal
growth in consumer electronics, and this division rocketed past Instruments several
years ago. Although Memory’s growth had tapered off, senior management generally
agreed that this division would receive the lion’s share of corporate attention and re-
sources because it is larger, more profitable, and, frankly, more exciting. After all, Bell
Memory is associated with the glamorous market for telecommunications and per-
sonal electronic devices, whereas Bell Instruments is associated with sewage and
sludge.
The financial assumptions and projections associated with the preliminary strate-
gic plans for the two divisions are shown in Tables 12-6 and 12-7. Based on the initial
strategic plans, each division is projected to have 5 percent annual growth for the
next five years and thereafter. The strategic plans also assume that the cost structures
of the two divisions will remain unchanged from the current year, 2002. Only partial
financial projections are shown in Tables 12-6 and 12-7, but when Bell’s management
decides on a final strategic plan, it will develop complete financial statements for the
company as a whole and use them to determine financing requirements, as described
in Chapter 11.
To evaluate the plans, Bell’s management applied the corporate valuation model
to each division, thus valuing them using the free cash flow valuation technique. Each
division has a WACC of 10.5 percent, and Table 12-8 shows the results. The three
key items are NOPAT, the required investment in operating capital, and the resulting
free cash flows for each year. In addition, the table shows each division’s horizon
value of operations at 2007, which is the end of the five years of explicit forecasts, cal-
culated with Equation 12-2. The value of operations at 2002 is the present value of
the free cash flows and the horizon value, discounted at the weighted average cost of
capital. As expected, Bell Memory has the greater value of operations, $709.6 million
versus $505.5 million for Bell Instruments. However, the managers were surprised to
see that Bell Memory’s market value added (MVA) is negative: $709.6 value of opera-
tions $870.0 required operating capital $160.4 million. In contrast, Bell In-
struments’ MVA is positive: $505.5 value of operations $200 operating capital
$305.5 million.TABLE 12-5 Financial Results for Bell Electronics Inc. (Millions of Dollars)Division 1: Division 2: Total
Bell Memory Bell Instruments Company
Sales $1,000.0 $500.0 $1,500.0
Operating capital 870.0 200.0 1,070.0
Earnings before interest and taxes (EBIT) 131.0 60.0 191.0
Net operating profit after taxes (NOPAT) 78.6 36.0 114.6
Operating profitability (NOPAT/Sales) 7.9% 7.2% 7.6%