Mini Case 473
You have been hired as a consultant to Kulpa Fishing Supplies (KFS), a 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 pres-
entation around the following questions:
a. List the two types of assets that companies own.
b. What are assets-in-place? How can their value be estimated?
c. What are nonoperating assets? How can their value be estimated?
d. What is the total value of a corporation? Who has claims on this value?
e. The first acquisition target is a privately held company in a mature industry. The company
currently has free cash flow of $20 million. Its WACC is 10 percent and it is expected to
grow at a constant rate of 5 percent. The company has marketable securities of $100 mil-
lion. It is financed with $200 million of debt, $50 million of preferred stock, and $210 mil-
lion of book equity.
(1) What is its value of operations?
(2) What is its total corporate value? What is its value of equity?
(3) What is its MVA (MVA Total corporate value total book value)?
f. The second acquisition target is a privately held company in a growing industry. The target
has recently borrowed $40 million to finance its expansion; it has no other debt or preferred
stock. It pays no dividends and currently has no marketable securities. KFS expects the
company to produce free cash flows of $5 million in 1 year, $10 million in 2 years, and $20
million in 3 years. After 3 years, free cash flow will grow at a rate of 6 percent. Its WACC is
10 percent and it currently has 10 million shares of stock.
(1) What is its horizon value (that is, its value of operations at Year 3)? What is its current
value of operations (that is, at time zero)?
(2) What is its value of equity on a price per share basis?
g. KFS is also interested in applying value-based management to its own divisions. Explain
what value-based management is.
h. What are the four value drivers? How does each of them affect value?
i. What is expected return on invested capital (EROIC)? Why is the spread between expected
ROIC and WACC so important?
j. KFS has two divisions. Both have current sales of $1,000, current expected growth of 5 per-
cent, and a WACC of 10 percent. Division A has high profitability (OP 6%) but high cap-
ital 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 percent? What is the MVA of each division if growth is 6 percent?
k. What is the expected ROIC of each division for 5 percent growth and for 6 percent growth?
How is this related to MVA?
l. The managers at KFS have heard that corporate governance can affect shareholder value.
List for them the two primary mechanisms of corporate governance.
m. Why is entrenched management potentially harmful to shareholders?
n. List three provisions in the corporate charter that affect takeovers.
o. Explain the difference between insiders and outsiders on the board of directors. What are
interlocking boards?
p. What is a stock option in a compensation plan?
See Ch 12 Show.pptand
Ch 12 Mini Case.xls.
470 Corporate Valuation, Value-Based Management, and Corporate Governance
