Syndicate:

Anthony 29117005
Andhika A. Anantafortuna 29117296
Ratu Millatina 29117096
Lazuardy K. Sadewa 29117149

Case Summary
Berkshire Hathaway Inc. is a famous company which also involves in many different business segments. It was originally operated as a cotton
manufacturing company. In 1965, Warren Buffet declared to take over the company and became the chairman and CEO of Berkshire Hathaway.
Since then, this company started to be well known by the world.

On May 24, 2005, Buffet announced that MidAmerican Energy Holding Company, a subsidiary of Berkshire Hathaway would acquire PacifiCorp
which is an electric utility company. He decided to use $5.1 billion in cash and $4.3 billion in liabilities and preferred stock to acquire PacifiCorp.
According to the data, on the day of announcement, Berkshire Hathaway’s Class A shares closed up 2.4% for the day and reached $2,010 per
share, for a gain in market value of $2.55 billion. This implies that market showed a promising attitude towards this acquisition.
Since Buffet is a well-known and successful investor, people trust his investment decision. They believed this acquisition would generate more
profits for them. Scottish Power’s share price jumped 6.28% and implied that people also consider PacifiCorp could be more profitable and provide
better service to citizens under the acquisition by MidAmerican.
1. What were the key principles that guided Buffett?
• Economic reality, not accounting reality.

Buffett stated that the limitation of conventional accounting is that it consolidated reported earnings that may reveal relatively little about
the company true performance. Accounting reality was conservative, backward-looking, on the other hand, investment decisions should be
based on the economic reality of business. In economic reality, intangible assets might be valuable. In economic reality, the results of a
business were its flow of cash, also the consistency of its operating history, the attractiveness of its long term prospects, the quality of
management, and the firm’s capacity to create value.
• The cost of the lost opportunity.

Buffett is comparing an investment opportunity against the next best alternative as the “lost opportunity”. In this case, Buffer saw the true
cost of an investment is what you give up (opportunity) to get it. This includes not only the money spent in buying that asset but also the
economic benefits that one has to do without because one bought that particular asset and thus can no longer buy something else with that
money.
• Value creation: time is money.

Buffett assessed intrinsic value as the present value of future expected of the business’ performance. Intrinsic value is defined as the
discounted value of cash that can be taken out of a business during its remaining life. It means that we should really pay attention to the
business future potential growth, not the amount of investment that we put.
• Measure performance by gain in intrinsic value, not accounting profit.

Those measures focus on the ability to earn returns in excess of the cost of capital. The gain in intrinsic value was analogous to the
economic-profit and market-value added measures used by analysts in leading corporations to assess financial performance.
• Risk and discount rates.
This principle creates the theory of “high risk-high return”, the more risk one took, the more one should get paid. Thus, discount rates used
in determining intrinsic values should be determined by the risk of the cash flow being valued, it can be calculated using CAPM, which
 added a risk premium to the long term risk-free rate of return, such as U.S. Treasury bond yield. Buffett define risk as “the possibility of
injury”. Risk (beta of stock) is the relative volatility in the past.
• Diversification.

Buffett disagreed with conventional wisdom that investors should hold a broad portfolio of stocks in order to shed company-specific risk.
He said that diversification is protection against ignorance, but if you don’t feel ignorant, the need for it goes down drastically. The meaning
behind it was diversification will be much better if it's accompanied with deep understanding on the business itself.
• Investing behavior should be driven by information, analysis, and self-discipline, not by emotion or “hunch”.

Buffett emphasized awareness and information as the foundation for investing. Over the long term, stock prices should have a strong
relationship with the economic progress of the business. Warren Buffett did not believe in the stock market. When he invested in stocks,
he invested in businesses. He behaved according to what is rational rather than according to what is fashionable. He didn’t try to “time the
market” (trade stocks based on expectations of changes in the market cycle). Instead, he employed a strategy of patient, long-term investing.
In conclusion, we can learn that it is essential to use intellect – not emotion – when investing.
• Alignment of agents and owners.

Buffett told that the owner of the company should act on behalf of the shareholder. He said that we will only do with your money what we
would do with our own. He stated that “I am a better businessman because I am an investor, and I am a better investor because I am a
businessman”.

2. Could those principles be applied broadly in the 21st century or were they unique to Buffett and his time?
Yes, these principles are the basis for someone to invest until today. Such as:
− In order to do an investment, we could do investment analysis using NPV and IRR. These method is aligned with Buffett principle by
discounting value of cash that can be taken out of an investment during its remaining life.
− The term "opportunity cost" comes up often in finance and economics when trying to choose one investment, either financial or capital,
over another. It serves as a measure of an economic choice as compared to the next best one.
 − We should do fundamental analysis if we would like to keep a stock for a long term. We need to think top-down, and also learn about the
business of the company if we would like to invest in that business.
− We need to diversify our portfolio, not diversify excessively, but do a well-diversification.
− We should pay only a reasonable price, even for an excellent business. So, before buying a stock, we could do a stock valuation to know
whether the stock is undervalued or overvalued. One way to do the calculation is using CAPM.

3. What were Buffett's probable motives in the acquisition?

Buffett try to utilize the cash equivalent worth $4 billion that are earning paltry returns. He need an “elephant” to make a significant gain.
Based on our discussion, the first motive was Buffett to try to invest the money to become a profitable investment, rather than the money to
just partly returns. Second, Buffett try to diversify the business line, to create larger market share and make significant gain; also to spread the
risk, rather than put all eggs in one basket. Lastly, based on our discussion, his motive is to dominate other business line by acquiring PacifiCorp
which is a leading, low-cost energy producer and distributor.

4. How would it compare with valuations for other regulated utilities?

PacifiCorp does not pay a dividend, because PacifiCorp is a subsidiary of Scottish Power. Company’s valuation implied by the multiples for
comparable firms is a more reasonable method than using market value. Exhibit 9 and Exhibit 10 present implied valuations for Pacifiers using
averages and medians of those firms' multiples. In the enterprise value comparison in Exhibit 10, it can be seen that Cinergy has the highest
value of $ 13.231 million followed by SCANA $ 7.967 million, PacifiCorp $ 7.954 million, Wisconsin $ 7.691 million, Alliant $ 5.600 million,
and NSTAR $ 5.287 million. Of the five companies, the average value is $ 7,955 million and the median is Wisconsin $ 7,691 million.

Based on Exhibit 9 and Exhibit 10, Cinergy Corp is the most valuable firm of comparable companies and the company most similar to Duke
Energy has acquired PacifiCorp, in a $ 9 billion stock exchange. In the comparison of market value equity in Exhibit 9, it can be seen that
Cinergy has the highest value of $ 7,989 million followed by SCANA $ 4,486 million, PacifiCorp $ 4,552 million, Wisconsin $ 4,048 million,
Alliant $ 3,333 million, and NSTAR $ 2,898 million. Of the five companies, the average value is $ 4,551 million and the median is Wisconsin
at 4,048 million.
 If Berkshire Hathaway offers $ 5.1 billion in cash to acquire PacifiCorp Equity and the deal will take 12 to 18 months, the present value of
Berkshire's offer is $ 4,665 million. Berkshire may obtain equity value from the acquisition of approximately $ 1,239 million.

5. How would Buffett define success?

According to Buffett's main focus, which is to maximize shareholder’s wealth, Buffett's success can be defined if its shareholders become
wealthier. Buffett is well-known to invest in an under-valued company and turned it into a multi-billion-dollar company, like the Columbia
University professor Benjamin Graham, who was also known for his development methods to identify undervalued stocks. Thus, successes
can also be defined if Buffett succeeds investing in an undervalued company and managed to bring it into a company that has higher value.

6. Would the PacifiCorp acquisition serve the long-term goals of Berkshire Hathaway?
In essence, Berkshire Hathaway has criteria for acquisitions, namely: large purchases, demonstrated consistent earning power, businesses
earning good returns on equity with no debt, management in place, simple businesses, and price issues. So, if Berkshire Hathaway has made
an acquisition, it is expected to be able to serve its short and long-term goals. From Exhibit 7, it can be seen that PacifiCorp has an increase in
asset value and net income, which shows that the company was in good condition and was still experiencing an increase. The impact of the
acquisition for Berkshire Hathaway was to make the company a stronger player in the energy sector through its MidAmerican Energy.

7. Was the bid price appropriate?

Before our syndicate assess the appropriateness of the bid price, we shall look at two things:
- Company’s intrinsic value; and
- Company’s valuation implied by the multiples for comparable firms.
- Discounted Cash Flow

Private firm valuation can use the Discounted Cash Flow method. We can first calculate the required return of the firm that can be found by
calculate the Weighted Average Cost of Capital (WACC). There are 2 components of the WACC which are the cost of debt and cost of equity.
The WACC value indicates the amount of return that the firm has to pay as the results of the financing.
- Cost of Debt
The long-term debt interest rate can be calculated from the Exhibit 7, which is 7%. While the tax rate is 40%. Based on these two
information, we can calculate the Cost of Debt.
𝑅𝑑 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 ∗ (1 − 𝑇𝑎𝑥 𝑅𝑎𝑡𝑒)
𝑅𝑑 = 7% ∗ (1 − 40%) = 4.20%

- Cost of Equity
Cost of equity can be found using the CAPM formula. The components of the CAPM formula are Risk free rate which is according to the
case is the yield on 30-year treasury bills 5.76%.
The market required return of equity is the average return of the stock market which is 10.50%, and risk premium is different amount of
risk market return and risk free rate.
The beta used for this formulation is the average beta of the industry which is 0.77
𝑅𝐸 = 𝑅𝐹 ∗ (𝛽 + (𝑅𝑀 − 𝑅𝐹 )
𝑅𝐸 = 5.76% ∗ (0.77 + (10.50% − 5.76%) = 9.41%

The weight for equity and debt can be calculated using the information of the acquisition where the $5,1 billion come from cash, while $4,3
billion come from debt. From this information the Weight of Equity (WE) = 54.26%, and the Weight of Debt (WD) = 45,74%.

𝑊𝐴𝐶𝐶 = 𝑊𝐷 ∗ 𝑅𝐷 + 𝑊𝐸 ∗ 𝑅𝐸
𝑊𝐴𝐶𝐶 = 7.027%
 2004 2005 2006 2007 2008 2009 2010 2011
Sales $ 3,194.50 $ 3,048.80 $ 3,201.24 $ 3,361.30 $ 3,529.37 $ 3,705.84 $ 3,891.13 $ 3,984.51
Sales growth 5% 5% 5% 5% 5% 5% 5% 2%
Depreciation and amortization $ 428.80 $ 436.90 $ 448.43 $ 470.85 $ 494.40 $ 519.11 $ 545.07 $ 572.32

EBITDA $ 1,046.70 $ 1,093.30 $ 1,088.42 $ 1,142.84 $ 1,199.98 $ 1,259.98 $ 1,322.98 $ 1,354.73

EBIT $ 617.90 $ 656.40 $ 639.99 $ 671.99 $ 705.59 $ 740.87 $ 777.91 $ 782.41
Interest expense $ 224.40 $ 236.20 $ 224.09 $ 235.29 $ 247.06 $ 259.41 $ 272.38 $ 278.92
EBT $ 393.50 $ 420.20 $ 415.90 $ 436.70 $ 458.53 $ 481.46 $ 505.53 $ 503.49
Income tax expense $ 144.50 $ 168.50 $ 166.36 $ 174.68 $ 183.41 $ 192.58 $ 202.21 $ 201.40
Net income $ 248.10 $ 251.70 $ 249.54 $ 262.02 $ 275.12 $ 288.88 $ 303.32 $ 302.10

Terminal Cash Flow $ 4,412.78

DCF to Year 2005 $ 251.70 $ 233.16 $ 228.74 $ 224.41 $ 220.16 $ 215.99 $ 3,137.00
Total $ 4,511.16

PP&E $ 9,036.50 $ 9,490.60 $ 9,965.13 $ 10,463.39 $ 10,986.56 $ 11,535.88 $ 12,112.68 $ 12,718.31

PP&E growth 105% 105% 105% 105% 105% 105%

Assumption:
- The depreciation we assume that 45% from the PP&E (From the historical data of 2004 and 2005)
- The interest is 7% while the tax rate is 40%.
- The sales growth for year 1 to year 5, we use the increase of 5% each year, while for year 6 to perpetuity, we use the GDP growth which
is 2%.

Intrinsic value is the present value of the future expected performance of a firm. Warren Buffet considers this is one of the most important
tools in investment, because PacifiCorp was privately held by Scottish Power, which means that PacifiCorp does not pay dividend. Company’s
valuation implied by the multiples for comparable firms is more reasonable method than using market value.
The PacifiCorp was worth $9.023 billion on its own before the acquisition. The value is taken from the median of Enterprise Value as multiple
of EBITDA from Exhibit 10. The EBITDA multiple is commonly used to compare firms in the same industry that has comparable level of
capital intensity, as the EBITDA used for operating cash flow for the firm. This method is better to be used for approaching the value of
PacifiCorp rather than the Discounted Cash Flow analysis. This is because the PacifiCorp is a private company, so the cash flow statement is
not publicly available. The enterprise value is used for this valuation because to minimizing the differences of accounting policy. The
disadvantage of using this method is when the comparable companies in the industry are mispriced, then it will be difficult to value the firm.

Exhibit 9 and Exhibit 10 present implied valuations for PacifiCorp using averages and medians of those firms’ multiples.
Dollars in Millions Enterprise Value as Multiple of: MV Equity as Multiple of:
MV Equity Enterprise Value Book Value EPS Rev EBIT EBITDA Net Income EPS Book Value
Alliant Energy Corp. $3,333.00 $ 5,600.00 $ 2,805.00 $1.42 1.89x 13.33x 7.45x 34,15x 20.33x 1,19x
Cinergy Corp. $7,989.00 $ 13,231.00 $ 3,178.00 $2.15 2.82x 17.93x - 32,75x 19.77x 1,91x
NSTAR $2,898.00 $ 5,287.00 $ 1,484.00 $1.78 1.79x 11.62x 7.53x 27.83x 15.25x 1,95x
SCANA Corp. $4,486.00 $ 7,967.00 $ 2,566.00 $2.34 2.05x 13.37x 9.25x 30.18x 16.99x 1,75x
Wisconsin Energy Corp. $4,048.00 $ 7,691.00 $ 2,522.00 $2.62 2.24x 14.51x 8.97x 25.13x 13.23x 1.61x
Median $4,048.00 $ 7,691.00 $ 2,566.00 $2.15 2.05x 13.37x 8.25x 30.18x 16.99x 1.75x
Mean $4,551.00 $ 7,955.00 $ 2,711.00 $2.06 2.16x 14.15x 8.30x 30.01x 17.11x 1.68x
Implied Value of PacifiCorp $ 3,377 $0.81 $ 6,252.00 $8,775.00 $ 9,023.00 $ 7,596.00 $ 4,277.00 $ 5,904.00
$ 6,584.00 $9,289.00 $ 9,076.00 $ 7,553.00 $ 4,308.00 $ 5,678.00

The figure above shows enterprise value multiples of comparable firms; the bid price derives from the table should be around $6,252 to $9,289
but Berkshire’s offers $9.4 billion to acquire PacifiCorp. Using this method apparently the bid price is not appropriate, Berkshire’s offers
measure was over-valued even though the enterprise value of PacifiCorp was above the enterprise value’s mean and median of comparable
firms.

PacifiCorp market value of equity was around $ 4,277 to $5,904. If Berkshire offered $5.1 billion cash to acquire PacifiCorp Equity and the
deal would take 12 to 18 months, the present value of Berkshire’s offer will be $4,665 million. Berkshire might gain equity value from the
acquisition about $1,239 million.
8. How did Berkshire's offer measure up against the company's valuation implied by the multiples for comparable firms?
Dollars in Millions Enterprise Value as Multiple of: MV Equity as Multiple of:
MV Equity Enterprise Value Book Value EPS Rev EBIT EBITDA Net Income EPS Book Value
Alliant Energy Corp. $3,333.00 $ 5,600.00 $ 2,805.00 $1.42 1.89x 13.33x 7.45x 34,15x 20.33x 1,19x
Cinergy Corp. $7,989.00 $ 13,231.00 $ 3,178.00 $2.15 2.82x 17.93x - 32,75x 19.77x 1,91x
NSTAR $2,898.00 $ 5,287.00 $ 1,484.00 $1.78 1.79x 11.62x 7.53x 27.83x 15.25x 1,95x
SCANA Corp. $4,486.00 $ 7,967.00 $ 2,566.00 $2.34 2.05x 13.37x 9.25x 30.18x 16.99x 1,75x
Wisconsin Energy Corp. $4,048.00 $ 7,691.00 $ 2,522.00 $2.62 2.24x 14.51x 8.97x 25.13x 13.23x 1.61x
Median $4,048.00 $ 7,691.00 $ 2,566.00 $2.15 2.05x 13.37x 8.25x 30.18x 16.99x 1.75x
Mean $4,551.00 $ 7,955.00 $ 2,711.00 $2.06 2.16x 14.15x 8.30x 30.01x 17.11x 1.68x
Implied Value of PacifiCorp $ 3,377 $0.81 $ 6,252.00 $8,775.00 $ 9,023.00 $ 7,596.00 $ 4,277.00 $ 5,904.00
$ 6,584.00 $9,289.00 $ 9,076.00 $ 7,553.00 $ 4,308.00 $ 5,678.00

Based on the multiples for comparable regulated utilities, we can see that in Exhibit 10, the range of possible enterprise values for PacifiCorp
was from $6.252 billion to $9.289 billion. And the range of possible market value of equity is $4.277 billion to $5.904 billion. In this case,
Berkshire used $9.4 billion to acquire the electric utility PacifiCorp. In the case, Buffett mentioned “intrinsic value is all important and is the
only logical way to evaluate the relative attractiveness of investment and business.”

The acquisition will last for 12 to 18 months, and the future cash flow will be $5.1 billion in cash; for the discount rate we use CAPM as basic
for calculation, from footnote 13, the risk-free rate of return equals to 5.76% (the yield on the 30-year U.S Treasury Bonds on May 2005) and
we used the beta of the industry which equals to 0.77. For the market risk, we used 10.50% as the average return of the market.

9. What might account for the share price increase for Berkshire Hathaway at the announcement?
The long-term goals of Berkshire Hathaway were succinct in that they value long-term investments in stable industries that are proven to pay
off in the future. After acquire the PacifiCorp, they will emerge with a greater presence in the energy sector and a hefty payoff in the long run.
The possible meaning of the change of the stock was that the facts are created in the deal had a positive effect on both the buyers (Berkshire
Hathaway) and the sellers which are the mother company of Pacific (Scottish Power). It would appear that the market sees more value accruing
to Scottish Power because of its divestiture of PacifiCorp than to Berkshire, as a result of its acquisition of the company.
 Looking at the Exhibit 10, the book value of PacifiCorp is equal to $3.377 billion divided by 312.18 million shares (Exhibit 9) would result to
$10.82 per share. Meanwhile the increase of $2.55 billion at the day of the announcement of Berkshire suggests that the true value of PacifiCorp
should be higher at $2.55 billion divided by 312.18 shares or $8.17 higher.

However, it also need to take into account that there is a possible of psychological factors in the behavior of the investor as they have the
tendency to trust Warren Buffet’s decisions given his history in the investing. It is also concerning that Berkshire Hathaway’s investments are
focus more on the energy sector. Warren Buffet has significant interests in this industry, and also what he calls “elephant” (a company that
makes significant gains). Warren Buffett also has a large sum of portfolio of utilities and transmission companies, which is MidAmerican
Energy Holdings Company.

10. What did Buffett's offer say about his valuation of PacifiCorp?
Our syndicate believe that when Berkshire Hathaway acquire the PacifiCorp, it would give additional values and PacifiCorp shows that its
intrinsic value is greater than the book value. The shareholders will also endorse this acquisition but need to consider to divest their money
into other industry aside from the energy industry. The bid for PacifiCorp of $9.4 billion seem reasonable relative to current comparable
valuations. For the PacifiCorp acquisition to be a success in the sense of matching historical returns at Berkshire Hathaway, Warren Buffett’s
expectations for PacifiCorp must be radically different from the implied and expected values for the compared firms.