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.

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

(D) The most reliable and straightforward way to determine a company's market value is to calculate what is called its market capitalization, which represents the total value of all shares outstanding. The market capitalization is defined as a company's stock value multiplied by its total number of shares outstanding. It is used a measure of a company's overall size.

It is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

Value of Firm = market value of common stock + market value of preferred equity + market value of debt + minority interest - cash and investments.

Majorly there are three methods to do valuation of the Firm

• Calculating Firm Value using Market Capitalization

  This method only works for publicly traded companies, where share values can be easily determined. A disadvantage of this method is that it subjects the company's value to the fluctuations of the market. If the stock market declines due to an external factor, the company's market capitalization will fall even if its financial health has not changed. Market capitalization, because it relies on investor confidence, is a potentially volatile and unreliable measure of a company's true value. Many factors go into to determining the price of a share of stock, and thus a company's market capitalization, so it's best to take this figure with a grain of salt. That said, any potential buyer for a company might have similar expectations to the market and place similar value on the company's potential earnings.

• Finding Market Value Using Comparable Companies

This valuation method works well if a company is privately held or if the market capitalization figure is deemed unrealistic for any reason. To estimate a company's value, look at the sales prices for comparable businesses.

• Determine Market Value Using Multipliers

  The most appropriate method for valuing small businesses is the multiplier method. This method uses an income figure, such as gross sales, gross sales and inventory, or net profit, and multiplies it by an appropriate coefficient to arrive at a value for the business. This type of estimate is best used as a very rough, preliminary valuation method because it ignores many important factors in determining the actual value of a company.

If we talk about claim on these value than , only equity holder can claim on these value as debt holder can claim up to their amount and interest part but they are not a owner of the Firm however equity investors hold ownership right.

(E)

$ 210 million- Equity

$ 50 million- Preferred stock

$ 200 million Debt

$ 100 million marketable securities

$20 million Cash Flow

WACC- 10 % and expected to grow at a constant rate of 5%

In case a company who don’t pay ant dividend means company only has to pay interest on debt

Ans. 1. - Valuation of Firm will be

      $210+$50+$1200+$100+$20-$20(10% of $200 debt)

= $ 560 million

Value of Equity = $210+$50

                             = $ 260 *                 * No Dividend paid

Ans. 2) – Value of Operation = $100 million +$ 20 million

                                                                = $120 million ( Value of operation means a value generate by investment . The outcome of business operations is the harvesting of value from assets owned by a business. Assets can be either physical or intangible.

Ans. 3)

MVA is (MVA = Total corporate value – Total book value)

Total Corporate Value is $560 million

Total Book value is a value which is also the net asset value of a company, calculated as total assets minus intangible assets (patents, goodwill) and liabilities.

Total book value= Total Assets- Intangible Assets – Liability

                                    $210 + $ 50 + $100 + $20 - $200    = $180

So MVA value = $560- $180     = $ 380

(F)

Equity - $ 10 million

Debt - $40 million

We have cash flow so let's calculate the NPV of cash flow

NPV = [CF1 / (1+r)1] + [CF2 / (1+r)2] + ... + [CFn / (1+r) n]

CF = Cash Flow

r= discount rate (WACC)

Present value of Cash Flow=

Cash Flow	Present value
-5	-4.54
10	8.26
20	15.03
	18.75	NPV

Total Value of the Firm = $ 10+$40+$18.75 million

                                                = $ 68.75 million

(G) Terminal value is the value of a project’s expected cash flow beyond the explicit forecast horizon. An estimate of terminal value is critical in financial modelling as it accounts for a large percentage of the project value in a discounted cash flow valuation. This tutorial focuses on ways in which terminal value can be calculated in a project finance model.

        TV = FCFt+1/ (r-g)

   Where FCF- Free cash Flow @ last year of projected period

R= rate WACC

g- Expected growth

Terminal Value = $20 million + 1/ (10-6)

                                                = $ 5.25 million

And value of operation will be $ 18.75 + $5.25 million

                                 = $ 24 million