c9 even answers

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Analysis for Financial Management , 10e

SUGGESTED ANSWERS TO EVEN-NUMBERED PROBLEMS

CHAPTER 9

2. The value of the bid to Newscorp’s shareholders is the value of theassets acquired in the merger. This includes the value of theequity acquired plus the liabilities assumed by the buyer. Theestimat4ed cost of the acquisition was thus ($! " #2 millionshares % $&.4 billion ' .# billion. This is an estimate becausethe boo) value of *ow +ones’s debt only appro"imates thepreferred mar)et value, although the appro"imation is probablyreasonably close.

4. a. The terminal value ' -!!(&%.!4/(.!#0.!4 ' $&#,2!!.*iscounting the annual free cash 1ows plus the terminal value at# percent, the 3 ' $&&,52.

b. The terminal value ' -!!(&%.!6/(.!-0.!6 ' $,-6!.*iscounting the annual free cash 1ow plus the terminal value at- percent, the 3 ' $26,-6-.

c. The 3 increases && percent when the discount rate falls onepercentage point and the perpetual growth rate rises by thesame amount. lausible changes in the discount rate and theperpetual growth rate can cause large changes in estimated7rm value. This is especially true when the initial rates aresimilar.

. a. 89:T ' $6! million. 3s a stand0alone company, typical debtwould be .4! " $26! million ' $&!! million. 3t a &!; interestrate, interest e"pense would be $&! million. Therefore, pro7tbefore ta" ' $6! < &! ' $4! million. ro7t after ta" ' $4!(&0.4' $2.4 million. Therefore the value of the division=s equityrelative to comparable 7rms is $2.4 " &2 ' $&.# million.3dding liabilities, >alue of division ' $&.# % $&!! ' $4&.#

million. This should be the owner=s minimum acceptable price.

b. ?rom the acquirer=s perspective, this is essentially a @ma)e0or0buy@ decision. 9ecause the acquirer can @ma)e@ a li)e operationfor a present value cost of $46! million, he should not pay morethan this to @buy@ the division. (This assumes the opportunitycosts of being slower to mar)et are included in the $46! millionprice.

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c. 3n acquisition appears feasibleA the owner=s minimum price isless than the buyer=s ma"imum.

d. Bedoing the answer to (a) at a &6 price0to0earnings ratio, thevalue of the division=s equity ' $2.4 " &6 ' $5, and adding

liabilities, the value of the division is now $5 % &!! ' $45.9ecause the owner=s minimum price is now more than the buyer=sma"imum, an acquisition does not ma)e economic sense.

e. The answer to (d) suggests that acquisition activity will decreasewhen mar)et value rises above replacement value. :n thissituation, companies 7nd it more e"pensive to @buy@ assets thanto @ma)e@ them. This is why economists are interested in +ames Tobin=s q-ratio, de7ned as the mar)et value of acompany/replacement value of its assets. Chen q rises,acquisition activity should fall, and vice versa.

#. a. Negative free cash 1ow simply means that the company will notbe able to fund all worthwhile activities in that year out ofoperating cash 1ows and needs to raise capital from outsidesources. Negative free cash 1ows are usually associated withgrowing companies.

b. Negative free cash 1ows do not compromise or invalidate thenotion that the value of the 7rm equals the present value of freecash 1ows, provided the securities sold to ma)e up the shortfallare fairly priced. They do mean that e"isting capital suppliers willhave to inDect added capital into the business or share future freecash 1ows with new investors. :n the latter case, this does notchange the value of the business to e"isting capital suppliersprovided the present value of the free cash 1ows sacri7cedequals the value of the capital raised from new investors.

c. The going0concern value of a company with negative e"pectedfree cash 1ows in all future periods is negative. Nonetheless, anequity investor might buy shares in such a company for at leasttwo reasonsE the e"pected liquidation value of equity might bepositive, and there might be a small but positive chance thepresent value of future free cash 1ows will be positive.

(Bemember, negative e"pected free cash 1ows does not rule outthe chance that actual cash 1ows might be positive. :n thislatter case, the stoc) can be viewed as an out0of0the0moneyoption, which is valuable. Fere’s a numerical e"ample. 3n all0equity, one0period company has a 5!; chance of generating a?G? ne"t year of 0$&!! and a &!; chance of generating %$6!. The e"pected ?G? is 0$#6, but due to limited liability, the payoH to


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shareholders is a 5!; chance at $! and a &!; chance at $6!,which has an e"pected value of $6.

10. The median and mean #alues for $cotts%s peers appear below.

&alues e'cludin( $cottsMedian Mean

)-year (rowth rate in sales *+, .) .0)-year (rowth rate in eps *+, ).1 /.nalysts% proected (rowth *+, .2 .3nterest co#era(e ratio *4, ). 5.1Total liabilities to assets *4, 0. 0.Total assets *6 millions, 5")1 "0/7

8rice9earnin(s *4, 15. 1.M& firm9E:3T*1-Ta' rate *4, 1. 1.0M& e;uity9sales *4, 1.5 1./M& firm9sales *4, 2.0 1.M& e;uity9:& e;uity *4, /.5 7.7M& firm9:& firm *4, 1.) 1.)

Here are my indicators of #alue for $cotts. 3n comin( to these numbers" 3 belie#ethat $cotts%s somewhat hi(her historical and proected (rowth rates" combined withdominant positions in its chosen mar<ets"warrant numbers that are in the upper halfof the indicated #aluation ran(es. Howe#er" the company%s somewhat smaller siesu((ests some caution. 3 ha#e selected multiples for the first two ratios rou(hly 10 percent abo#e the sample median and ) percent abo#e the mean. $cotts%s mediocre

(ross mar(ins" especially for a company that dominates its mar<ets" su((est thatin#estors will pay less per dollar of sales for $cotts than for peers" resultin( in lowerthan a#era(e multiples for the ne't two ratios. 3 ha#e chosen representati#emultiples for the last two ratios.

8rice9earnin(s *4, 1.M& firm9E:3T*1-Ta' rate *4, 1.7M& e;uity9sales *4, 1.1M& firm9sales *4, 1.)M& e;uity9:& e;uity *4, 7.0

M& firm9:& firm *4, 1.)

The implied #alue of $cotts%s common stoc< for each indicator is=


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>oo<in( at these numbers"my best (uess of a fair price for $cotts%s shares on !o#ember 1" 200 is$33.00. 3 thin< 62. is the best sin(le estimate" but becauseall of the other estimated #alues are abo#e this fi(ure" 3 ha#e raised my best (uess byabout 10 percent. 6//.00 compares to an actual price on the #aluation date of6/.5" so my estimate is about 1 percent low" within my notion of the tolerancesinherent in business #aluation. Many other estimates are" of course" possible.

12. 8rice per share ? 6) million9700"000 shares ? 612.)0 per share. 8re-money #alue ?1.5 million shares 4 612.)0 ? 620 million. 8ost-money #alue ? 2 million shares 4

612.)0 ? 62) million. lternati#ely" post-money #alue ? pre-money #alue @6)million ? 62) million.


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17.

15. $ee AB8roblem-15Bnswer.'ls' on this Ceb site.


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c9 even answers

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