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• Book value of land may understate market value
• Prepaid assets such as insurance can be liquidated with a portion of the premium recovered.
13 Asset-Based Method: Break-Up Value
• Target is viewed as a series of independent operating units, whose income, cash flow, and balance sheet statements reflect intra-company sales, fully-allocated costs, and operating liabilities specific to each unit
• After-tax cash flows are valued using market-based multiples or discounted cash flows analysis to determine operating unit’s current market value
• The unit’s equity value is determined by deducting operating liabilities from current market value
• Aggregate equity value of the business is determined by summing equity value of each operating unit less unallocated liabilities and break-up costs 14 Illustration
• LAFCO Industries believes that its two primary product lines, automotive and commercial aircraft valves, are rapidly becoming obsolete. Its free cash flow is rapidly diminishing as it loses market share to new firms entering its industry. LAFCO has $200 million in debt outstanding. Senior management expects the automotive and commercial aircraft valve product lines to generate $25 million and $15 million, respectively, in earnings before interest, taxes, depreciation, and amortization next year. Senior management also believes that they will not be able to upgrade these product lines due to declining cash flow and excessive current leverage. A competitor to its automotive valve business last year sold for 10 times EBITDA. Moreover, a company that is similar to its commercial aircraft valve product line sold last month for 12 times EBITDA. Estimate LAFCO’s breakup value before taxes. 15 Replacement Cost Method
• All target operating assets are assigned a value based on what it would cost to replace them....
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