Question

Mini Case 1
Situation
Your employer, a mid-sized human resources management company, is considering expansion into related fields, including the acquisition of Temp Force Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporary heavy workloads. Your employer is also considering the purchase of a Biggerstaff & McDonald (B&M), a privately held company owned by two friends, each with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is expected to grow at a constant rate of 5%. B&M’s financial statements report marketable securities of $100 million, debt of $200 million, and preferred stock of $50 million. B&M’s weighted average cost of capital (WACC) is 11%. Answer the following questions.
Use B&M’s data and the free cash flow valuation model to answer the following question(Fill out the cell in YELLOW).
INPUT DATA SECTION: Data used for valuation (in millions)
Free cash flow		$24.0
WACC		11%
Growth		5%
Short-term investments		$100.0
Debt		$200.0
Preferred stock		$50.0
Number of shares of stock		10.0
(1) What is its estimated value of operations?
Vop =	FCF1	=	FCF0 (1+gL)
	(WACC-gL)		(WACC-gL)
Vop =
Vop =
(2) What is its estimated total corporate value?
Value of Operation
Plus Value of Non-operating Assets
	Total Corporate Value
(3) What is its estimated intrinsic value of equity?
Debt holders have the first claim on corporate value. Preferred stockholders have the next claim and the remaining is left to common stockholders.
Total Corporate Value
Minus Value of Debt
Minus Value of Preferred Stock
	Intrinsic Value of Equity
(4) What is its estimated intrinsic stock price per share?
Intrinsic Value of Equity
Divided by number of shares
	Intrinsic price per share
Estimating the Value of R&R’s Stock Price (Millions, Except for Per Share Data)
INPUTS:
			Value of operations =
			Value of nonoperating assets =
			All debt =
			Preferred stock =
			Number of shares of common stock =
ESTIMATING PRICE PER SHARE
			Value of operations
			+ Value of nonoperating assets
			Total estimated value of firm
			− Debt
			− Preferred stock
			Estimated value of equity
			÷ Number of shares
			Estimated stock price per share =

Answer 1

NOTE: In order to explain the various types of values of an entity it is important to consider the basic asset liability equation listed below:

Assets = Shareholder's Equity + Liability

The Asset portion comprises of the operating asset and non-operating asset part. The operating assets as the name suggests is the value of the company's/entity's operations and is the same thing which is determined using such methods as DCF, Gordon's Growth Model, Two Stage DCF, Terminal Value, etc. The non-operating asset comprises of intangible such as Intellectual Property, Goodwill, R&D intrinsic value, short-term financial instruments, cash, cash equivalents, minority holdings in other companies, etc.

The shareholder's equity part comprises of the common stock's value (which is usually the company's market capitalization), preferred stock value, the value of convertible preferred stocks, warrants, options and more.

Liability is usually the company's/entity's long-term interest-bearing debt, which is usually in the form of bonds.

(1)

Free Cash Flow (today at t=0) = FCFF0 = $ 24 million

Annual growth rate = 5 % = g, WACC = 11%

FCFF1 (Free Cash Flow after one year at t=1) = 24 x 1.05 = $ 25.2 million

Value of Operating Assets = FCFF1 / (WACC - g) = 25.2 / (0.11 - 0.05) = $ 420 million

(2) Total Corporate Value would be equal to Value of Operating Assets plus Value of non-Operating Assets.

Non-Operating Assets, in this case, would comprise of only the short-term investments worth $ 100 million

Therefore,

Total Corporate Value = Value of Operating Assets + Short Term Investments = 420 + 100 = $ 520 million.

(3) Intrinsic Equity Value

= Total Corporate Value - Value of Debt - Value of Preferred Equity

= 520 - 200 - 50

= $ 270 million

(4) Price per share (of common stock and not preferred stock) = Intrinsic Equity Value / Number of Common Shares = $ 270 million / 10 million = $ 27