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

A) Two types of assets that a company owns are -

• Current Assets - These are those assets which can be converted to cash within a year. Some of the assets that come under current assets are - cash, marketable securities, accounts recievables, prepaid expenses, inventories etc.
• Fixed Assets - These are those assets which are purchased for long term use and are not likely to be converted to cash within the coming year. Examples of fixed assets are - land, buildings, plant and machinery, office equipments etc.

B) Assets-in-place are the assets that the company already invested in and therefore are not needed to buy again for a investment strategy they are required. Examples of assets in place are property, plant and equipments etc.

Their value can be estimated in the following ways -

1. Net present value of the cash flows that it can generate discounted at an appropriate interest rate.
2. Another way is to calculate the replacement cost of the asset. That value will be the value of assets in place.

C) Non operating assets are those assets which are owned by the company that are not used in day to day busniess but are kept in place as they may generate income or provide return on investment. Examples of non operating assets are investment in stocks, bonds and other market instruments.

Their value is estimated by calculating the present value of the coupons (In case of coupon bearing bonds) they provide over time plus the present value of maturity value.

D) Total value of a company is deifned as the value which some one has to pay of he/she has to buy each and every share of a company. It is also known as enterprise value. It is calculated as the market capitalization plus debt, minority interest and preferred shares minus total cash and cash equivalents.

The firm share holders have claim over this value.