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CHAPTER 12
Corporate Valuation and ValueBased Management
Corporate Valuation
Value-Based Management
Corporate Governance
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Corporate Valuation:
List the two types of assets that a
company owns.
Assets-in-place
Financial, or nonoperating,
assets
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Assets-in-Place
Assets-in-place are tangible, such as
buildings, machines, inventory.
Usually they are expected to grow.
They generate free cash flows.
The PV of their expected future free
cash flows, discounted at the WACC,
is the value of operations.
Copyright 2002 Harcourt, Inc.
12 - 4
Value of Operations
VOp
t 1
FCFt
t
(1 WACC )
All rights reserved.
12 - 5
Nonoperating Assets
Marketable securities
Ownership of non-controlling
interest in another company
Value of nonoperating assets usually
is very close to figure that is
reported on balance sheets.
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Value of Operations:
Constant Growth
Suppose FCF grows at constant rate g.
FCFt
VOp
t
t 1 1 WACC
FCF0 (1 g )
t
t 1 1 WACC
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VOp
t 1
1 g
FCF0
1 WACC
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FCF1
VOp
WACC g
FCF0 (1 g )
WACC g
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FCF0 (1 g )
VOp
WACC g
20 (1 0.05)
VOp
420
0.10 0.05
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12 - 14
Value of Equity
Sources of Corporate Value
Value of operations = $420
Value of non-operating assets = $100
Claims on Corporate Value
Value of Debt = $200
Value of Preferred Stock = $50
Value of Equity = ?
Copyright 2002 Harcourt, Inc.
12 - 15
Value of Equity
Total corporate value = VOp + Mkt. Sec.
= $420 + $100
= $520 million
Value of equity = Total - Debt - Pref.
= $520 - $200 - $50
= $270 million
Copyright 2002 Harcourt, Inc.
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MVA
500
Book equity
400
Equity (Market)
300
Preferred stock
200
Debt
100
0
Sources Claims Market
of Value on Value vs. Book
Marketable
securities
Value of operations
All rights reserved.
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Horizon Value
Free cash flows are forecast for
three years in this example, so the
forecast horizon is three years.
Growth in free cash flows is not
constant during the forecast,so we
cant use the constant growth
formula to find the value of
operations at time 0.
Copyright 2002 Harcourt, Inc.
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FCFt (1 g )
HV VOp at time t
WACC g
Horizon value is also called terminal
value, or continuing value.
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12 - 23
4
g = 6%
FCF=
-5.00
10.00
20.00
21.2
-4.545
8.264
15.026
Vop at 3
398.197
416.942
Vop
$21.2
$530.
0 .10 0.06
All rights reserved.
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MVA t
Sales t (1 g )
WACC g
CR
OP WACC
(1 g )
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Sales t (1 g )
WACC g
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Insights (Cont.)
The second bracket is the operating
profit (as a %) the firm gets to keep,
less the return that investors require
for having tied up their capital in the
firm.
CR
OP WACC
(1 g )
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CR
OP WACC
(1 g )
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NOPAT t 1
EROIC t
Capital t
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Division B
OP 6% 6% 4% 4%
CR 78% 78% 27% 27%
Growth 5% 6% 5% 6%
MVA(300.0) (360.0) 300.0 385.0
Note: MVA is calculated using the
formula on slide 12-27.
Copyright 2002 Harcourt, Inc.
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Division B
Capital0 $780$780$270$270
Growth 5% 6% 5% 6%
Sales1 $1,050 $1,060 $1,050$1,060
NOPAT1 $63 $63.6 $42 $42.4
EROIC0
8.1%
8.2%
15.6% 15.7%
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Entrenched Management
Occurs when there is little chance
that poorly performing managers will
be replaced.
Two causes:
Anti-takeover provisions in the
charter
Weak board of directors
Copyright 2002 Harcourt, Inc.
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Anti-Takeover Provisions
Targeted share repurchases (i.e.,
greenmail)
Shareholder rights provisions (i.e.,
poison pills)
Restricted voting rights plans
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Board of Directors
Weak boards have many insiders
(i.e., those who also have another
position in the company) compared
with outsiders.
Interlocking boards are weaker (CEO
of company A sits on board of
company B, CEO of B sits on board
of A).
Copyright 2002 Harcourt, Inc.
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