Corporate Valuation, Value-Based Management, and
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS
include cash required for liquidity purposes,
inventories, receivables, and fixed assets necessary to operate a
include financial assets like
marketable securities (above the level needed for liquidity) and
investments in other businesses.
We make this distinction because we
want to find the value of the firm’s operations as a going concern and
then add the value of the non-operating assets to find the firm’s total
This breakdown is useful in management, where line managers have
control over operating assets but not over financial assets (which are
under the control of top management and under the supervision of the
Managers are judged and compensated on the basis of the
returns they produce on the operating assets under their control, and
for this purpose it is essential to segregate assets over which
managers do and do not have control.
The breakdown is also useful when
valuing firms for purposes of mergers, spin-offs, IPOs, and the like,
because it is helpful to find the value of operations and the separate
value of any non-operating asset the firm might hold.
In the BOC model, we assume that all of the firm’s assets are needed
These assets total to 70% of sales, or 0.7($200) = $140
in 2001, and they are forecasted to grow over time at the same rate as
Net working capital is current assets minus the sum of A/P and
accruals, which is (35% - 15%)($200) =
0.2($200) = $40 in 2001.
Again, this number is expected to grow with sales.
Free cash flow (FCF)
is generally taken to mean the cash flow generated
by operations less the new investment in operating assets required to
keep the business going so that it can generate cash flows in the
In other words, FCF is the amount of cash flow that can be
paid out as dividends or interest, used to repurchase stock or retire
debt, invested in assets to support growth, or invested in other
FCF can be calculated as follows:
FCF = NOPAT – Required investment in operating assets,
NOPAT = EBIT(1 – T),
Net Operating W.C.
Op. C.A. -
(A/P and Accruals)] +
Net F. A.
FCF can be calculated for past years from the financial statements, but
for valuation purposes the FCF of interest is the estimated future
stream of FCF. For our firm in 2002, FCF is $14.4 - $14 - $14 + $6
as detailed in the model printout shown at the end of the answer.
Answers and Solutions:
10 - 1