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Unformatted text preview: REVIEW QUESTIONS 131 and interpret forward—looking comparables, independent of capital structure
and other nonoperating items. scribed in rlier is to 2,3311: Real Options Using Replicating Portfolios First, the In 1997 Robert Merton and Myron Scholes won the Nobel Prize in economics for flow after developing an ingenious method to value derivatives that avoids the need to st of cap estimate either cash ﬂows or the cost of capital. (Fischer Black would have been .en made, named as a third recipient, but the Nobel Prize is not awarded posthumously.) 1ch as ac— Their model relies on what today’s economists call a “replicating portfolio.” 1 product They argued that if there exists a portfolio of traded securities whose future cash y. By dis ﬂows perfectly mimic the security you are attempting to value, the portfolio y assume and security must have the same price. As long as we can find a suitable it can be replicating portfolio, we need not discount future cash flows. esult will Given the model’s power, there have been many recent attempts to trans— the bias. late the concepts of replicating portfolios to corporate valuation. This valuation a formal technique is commonly known as real options. Unlike those for financial op— ommend tions, however, replicating portfolios for companies and their projects are diffi—
cult to create. Therefore, although options—pricing models may teach powerful
lessons, today's applications are limited. We cover valuation using options
based models in Chapter 32. I TWO ad_ SUMMARY options.
This chapter described the most common DCF valuation models, with partic—
ular focus on the enterprise DCF model and the economic—profit model. We
explained the rationale for each model and reasons why each model has an
important place in corporate valuation. The remaining chapters in Part Two de 3 g0 Plib' scribe a stepby—step approach to valuing a company. These chapters explain nterprlse the technical details of valuation, including how to reorganize the financial ’Our DCF statements, analyze return on invested capital and revenue growth, forecast the mOSt free cash flow, compute the cost of capital, and estimate an appropriate terminal gs before value. V / EBITA presenta— mine the REVIEW QUESTIONS ultiple in :stirnated m? If not, 1. Exhibit 6.18 presents the income statement and reorganized balance sheet for 3W faster BrandCo, an $800 million consumer products company. Using the method OIOgy outlined in Exhibit 6.5, determine NOPLAT for year 1. Assume an
s misum Operating tax rate of 25 percent. Using the methodology outlined in Exhibit
, to build 66, determine free cash ﬂow for year 1. ....mt,_...,.m.._.,.i..a....z“an. . v" we... .............. again...“ .Mm ..ii...m,..,,. ._..,.... ... z... ......... ._. .. .. . Mm. . . 132 FRAMEWORKS FOR VALUATION EXHIBIT 6.18 BrandCo: Income Statement and Reorganized Balance Sheet
_——_____—___—__\ $ million
income statement Reorganized balance sheet Today Year1 Today Yeaf1
Revenues 800.0 840.0 Operating working capital1 70.1 73.8
Operating costs (6400) (6720) Property and equipment 438.4 460.3
Depreciation (40.0) (42.0) Invested capital 508.5 533.9
Operating proﬁt 120.0 128.0 Debt 200.0 210.0
interest expense (16.0) (16.0) Shareholders’ equity 308.5 323.9
Earnings before taxes 104.0 110.0 Invested capital 508.5 533.9 Taxes (26.0) (27.5)
Net income 78.0 82,5 1 Accounts payabie has been netted against inventory to determine operating working capitai. . BrandCo currently has 50 million shares outstanding. If BrandCo’s shares
are trading at $19.16 per share, what is the company’s market capitaliza
tion (value of equity)? Assuming the market value of debt equals today’s
book value of debt, what percentage of the company’s enterprise value is
attributable to debt, and what percentage is attributable to equity? Using
these weights, compute the weighted average cost of capital. Assume the
pretax cost of debt is 8 percent, the cost of equity is 12 percent, and the
marginal tax rate is 25 percent. . Using free cash flow computed in Question 1 and the weighted average
cost of capital computed in Question 2, estimate BrandCo’s enterprise value
using the growing—perpetuity formula Assume free cash flow grows at
5 percent. . Assuming the market value of debt equals today’s book value of debt, what
is the intrinsic equity value for BrandCo? What is the intrinsic value per
share? Does it differ from the share price used to determine the cost of
capital weightings? . What are the three components required to calculate economic profit?
Determine BrandCo’s economic profit in year 1. . Using economic profit calculated in Question 5 and the weighted average
cost of capital computed in Question 2, value BrandCo using the economic—
profit—based key value driver model. Does the calculation generate enter
prise value or equity value? Should discounted economic proﬁt be greater
than, equal to, or less than discounted free cash ﬂow? Hint: remember, prior
year invested capital must be used to determine ROIC and capital charge. . Using the methodology outlined in Exhibit 6.16, determine equity cash ﬂow
for year 1. Use the growing—perpetuity formula (based on equity cash flow)
to compute BrandCo’s equity value. Assume the cost of equity is 12 percent
and cash flows are growing at 5 percent. ...
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This note was uploaded on 06/06/2011 for the course FINA 4210 taught by Professor Staff during the Spring '08 term at University of Georgia Athens.
 Spring '08
 Staff
 Corporate Finance

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