Question

NewPoint Company

You have been hired as a consultant to NewPoint company that is seeking to increase its value. NewPoint has asked you to estimate the value of two privately held companies that NewPoint is considering acquiring. But first, the senior management of NEWPOINT would like for you to explain how to value companies that don't pay any dividends. You have structured your presentation around the following questions.

A) List the two types of assets that companies own.    

B) What are assets-in-place? How can their value be estimated?

C) What are non-operating assets? How can their value be estimated?

D) What is the total value of a corporation? Who has claims on this value?

E) The first acquisition target is a privately held company in a mature industry. The company currently has free cash flow of $20 million. Its WACC is 10% and it is expected to grow at a constant rate of 5%. The company has marketable securities of $100 million. It is financed with $200 million of debt, $50 million of preferred stock, and $210 million of book equity.

1 What is its total corporate value? What is its value of equity?

2 What is its value of operations?

3 What is its MVA (MVA = Total corporate value – Total book value)?

F) The second acquisition target is a privately held company in a growing industry. The target has recently borrowed $40 million to finance its expansion; it has no other debt or preferred stock. It pays no dividends and currently has no marketable securities. NEWPOINT expects the company to produce free cash flows of -$5 million in one year, $10 million in two years, and $20 million in three years. After three years, free cash flow will grow at a rate of 6%. Its WACC is 10% and it currently has 10 million shares of stock.

G) What is its terminal (horizon value)? What is its current value of operations (i.e., at time zero)?

H) What is its value of equity on a price per share basis?

I) NewPoint is also interested in applying value-based management to its own divisions.

J) Explain what value-based management is.  

K) What are the four value drivers? How does each of them affect value?

What is expected return on invested capital (EROIC)?Why is the spread between EROIC and WACC so important?What is the EVA?

L) NewPoint has two divisions. Both have current sales of $1,000, current expected growth of 5%, and a WACC of 10%. Division A has high profitability (OP=6%) but high capital requirements (CR=78%). Division B has low operating profitability (OP=4%) but low capital requirements (CR=27%). What is the MVA of each division, based on the current growth of 5%? What is the MVA of each division if growth is 6%?

N) What is the EROIC of each division for 5% growth and for 6% growth? How is this related to MVA?

Answer 1

Answer to a)

Two types of assets that a company owns are operating and non operating assets. Operating assets can include cash; bank balance inventory etc. of the company and non operating assets can be any real estate investments of the company, excess cash balance.

Answer to b)

Assets in place can be property, plant, equipment, inventory and land. This is nothing but how a value is placed on the things that are being used in the business.

The value of assets in place is calculate by calculating replacement cost by including shipping for everything except land and buildings, calculating installation and configuration in case of equipment. Then you have to calculate depreciation as most of the stuff is not new and time and use extract value.

In other words, in attempt to evaluate all the parts, let’s look at whole thing as income generating business. The value is equal to net present value of stream of income discounted at appropriate interest rate. This is considered to be organic way of evaluating the assets. It is considered to be more realistic when the company goes for buying a business.

Answer to c)

Non operating assets:

A non operating assets are those that are not essential operations of ongoing business but still provides income or return on investment. The company may hold such assets with the intention of selling them or using it in the future. The value of non operating assets count towards total worth of the company. However the value is excluded from financial models that estimate the future growth or profit earning potential of the business segments. This is for the reason that non operating assets bring revenue, they don’t add to core revenue of the business.

Answer to d)

A corporation is valued by the assets that the company holds like real estate properties, stocks and other investments, equipment and other machinery. By calculating various ratios like P/E ratio, earnings per share. Other factors like brand reputation, clients, quality service rendered to the customers etc. these are considered as intangible factors for evaluating the corporation.

Answer to j)

Value based management:

Value based management is a approach that ensures companies are run on value i.e. maximizing the shareholder’s value. It includes the following:

• Creating value. I.e. ways o increase or generate maximum future value.
• Managing for value. I.e. governance, change management, organization culture, communication, leadership etc.
• Measuring the value.