Commercial Fixtures Inc. + Business valuation overview Suggested questions for the Commercial Fixtures Inc. case are given below. 1. What would you as an outside third party bid under the same conditions (with the same information) for the entire company (both halves)? Why? 2. What do you expect Albert Evans to bid for Gordon’s half interest? Why? 3. What should Gordon Whitlock bid for Albert’s half interest? Why? 4. How would you structure the purchase of the business? Question #1 is a business valuation question. There are a number of ways to estimate the value of a business. You have probably covered one or more of these ways in a previous class. The next two pages review a few of the various ways …show more content…
(A five year horizon is common, but this can vary.) Typically you will use the WACC as your discount rate. Depending on the circumstances, the estimated cash flows may be available for fewer than five years, or more than five years. b. Estimate the PV of the terminal value. One estimate for the terminal value involves assuming perpetual cash flows after the initial time horizon, e.g.: i. If the cash flow after 5 years is expected to grow at a rate g for the foreseeable future: Terminal Value5 (TV5) = FCF6 /(k – g) = FCF5 (1+ g) / (k – g)., where k is the required rate of return. You must discount the TV to time 0, and then add this to the PV of the FCFs during the projection horizon. ii. If the cash flow at the end of 5 years is not expected to grow, i.e., g=0, then the general formula collapses to the PV of a no-growth perpetuity: Terminal Value5 = FCF6 / (k-g) = FCF5 (1+ g)/(k – g) = FCF5 / k c. Use the Value of the Firm equation above, i.e. sum PV of free cash flows + PV of terminal value . The Value of the firm’s Equity = Value of the Firm – Debt Currently Outstanding. 3. (ii.) Adjusted Present Value approach — we will only briefly discuss this approach; a topic for a future finance course. 4. Comments on Valuing the Firm using DCF (or WACC) and APV valuation approaches a. Watch the free cash flows (not reported earnings)! In particular, as in the capital budgeting decision process: --Depreciation
For the purpose of calculating the net present value of the project, an appropriate cost of capital has to be calculated at which free cash flows of the project should be discounted. Since the project will be solely financed by selling new shares, cost of equity will be used as the discount rate. Beta for the company can be assumed to be equal to average of the betas of the competitors of the company. This average beta value comes out to be 1.2. Risk free rate is 0.17% while risk premium has been estimated to be 6%. Thus by putting these values in CAPM formula, we can find the cost of equity for the company which is 7.39%.
In order to arrive at the non-operating cash flows in year 10, we must add together the net cash flows from investing and financing activities. The non-operating cash flow when the project is terminated in year 10 is $902,000.
John Liedtke head of Active Gear, Inc. (AGI) is contemplating whether to invest in Mercury Athletic a subsidiary of West Coast Fashions (WCF). Mercury was purchased by WCF in hopes to increase business revenue however this was not the case. Business did not do as expected, WCF was then eager to abandon its apparel. John Liedtke saw this as an opportunity to take over Mercury and as result increase its business revenue. In order to determine whether this is an essential business opportunity John needs to complete preliminary financial valuations to make a solid decision.
Before moving forward to compute the present value of these cash flows, a terminal value is required to forecast the long term value of the company after 5 years. . Following formula is used to calculate the terminal value.
We assume that risk free rate (Rf) equals rate of long-term Treasury Bonds (as the project’s life is 10 years), so Rf = 9.5%.
b) As a third party under the same conditions (i.e. with the same information), what would you bid for the entire company (both halves)? Why?
13. What is the formula for the Present Value (PV) for a finite stream of cash flows (1 per year) that lasts for 10 years?
Step Three: Draw out a timeline, and then take the present value of all cash flows
IRR is the rate at which the net present value becomes zero (Ross, Westerfield & Jordan, 2013). Additionally, IRR is calculated first by determining the Net Present Value. The Net Present Value is the variance concerning the market value and its cost (Ross, Westerfield & Jordan, 2013). Net present value is calculated by first finding the present value. For instance, 21.83 million (year 1 revenue from above) divided by 1 plus the companies rate of return of 12%. Thus, 21.83/(1+.12)= 19.49 is the present value for year 1. Furthermore, by adding the total revenue over the next 5 years we get 21.85+ 28.025+36.875+30.975+23.6=132.325 million is the expected value of revenue. That amount now needs to be placed into the present value equation previously discussed only this time with the exponent of 5 to cover the next 5 years. 132.325/(1+.12)^5=75.08 (rounded). Moreover, if
3. Wasserstein, Perella & Co. established a valuation range of $68-$80 per common share for Interco. Show that this valuation range can follow from the assumptions described in the discounted cash flow analysis section of Exhibit 12. As a member of Interco’s board, which assumptions would you have questioned? Why?
The next step was to calculate the free cash flows for the eleven-year period. In order to do so, we used to following formula: FCF = EBIT(1-tax) + depreciation - change in NWC – CapEx. From here, we used to WACC of 13.89% previously calculated, in order to find the present value of each FCF.
* Determine the investment’s value without leverage, VU, by discounting its free cash flows at the
1. Identify comparable firms that have growth, cashflow and risks similar to those of target firm whose value is in question.
Taking the CAPM equation, we were able to figure out eh cost of equity and in its credit range
What is the relevance of the terminal year cash flow? Which factors must be considered when estimating the terminal year cash flow?