Chapter 09 - Business Valuation and Corporate Restructuring

Chapter 09
Business Valuation and Corporate Restructuring

Multiple Choice Questions

1. Which of the following statements are correct?

I. Liquidation value of a firm is equal to the present worth of expected future cash flows from
operating activities.
II. When an acquiring firm purchases a target firm's equity, the acquirer must assume the
target's liabilities.
III. The market value of a public company reflects the worth of the business to minority
investors.
IV. The fair market value of a business is usually the lower of its liquidation value and its
going-concern value.
A. I and III only
B. II and IV only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
F. None of the above.

2. Ginormous Oil entered into an agreement to purchase all of the outstanding shares of Slick
Company for $60 per share. The number of outstanding shares at the time of the
announcement was 82 million. The book value of liabilities on the balance sheet of Slick Co.
was $1.46 billion. What was the cost of this acquisition to the shareholders of Ginormous
Oil?
A. $1.46 billion
B. $3.46 billion
C. $4.92 billion
D. $6.38 billion
E. $8.38 billion
F. None of the above.

9-1
Chapter 09 - Business Valuation and Corporate Restructuring

3. Ginormous Oil entered into an agreement to purchase all of the outstanding shares of Slick
Company for $60 per share. The number of outstanding shares at the time of the
announcement was 82 million. The book value of liabilities on the balance sheet of Slick Co.
was $1.46 billion. Immediately prior to the Ginormous Oil bid, the shares of Slick Co. traded
at $33 per share. What value did Ginormous Oil place on the control of Slick Co.?
A. $2.21 billion
B. $2.71 billion
C. $4.17 billion
D. $6.38 billion
E. None of the above.

4. Which of the following statements is/are correct?

I. Going-concern value of a firm is equal to the present value of expected net income.
II. When a buyer values a target firm, the appropriate discount rate is the buyer's weighted-
average cost of capital.
III. The liquidation value estimate of terminal value usually vastly understates a healthy
company's terminal value.
IV. The value of a firm's equity equals the discounted cash flow value of the firm minus all
liabilities.
A. II only
B. III only
C. I and II only
D. II and III only
E. II, III, and IV only
F. None of the above.

9-2
Chapter 09 - Business Valuation and Corporate Restructuring

5. Which of the following statements are correct?

I. Going-concern value of a firm is equal to the present value of expected future cash flows to
owners and creditors.
II. When an acquiring firm purchases a target firm's equity, the acquirer need not assume the
target's liabilities.
III. The market value of a public company reflects the worth of the business to minority
investors.
IV. The fair market value of a business is usually the lower of its liquidation value and its
going-concern value.
A. I and III only
B. II and IV only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
F. None of the above.

9-3
Chapter 09 - Business Valuation and Corporate Restructuring

6. The following table presents forecasted financial and other information for Scott's Miracle-
Gro Co.:

What is an appropriate estimate of Scott's terminal value as of the end of 2014, using the
perpetual-growth equation as your estimate?
A. $161 million
B. $363 million
C. $3,690 million
D. $3,838 million
E. $5,357 million
F. None of the above.

9-4
Chapter 09 - Business Valuation and Corporate Restructuring

7. The following table presents forecasted financial and other information for Scott's Miracle-
Gro Co.:

What is an appropriate estimate of Scott's terminal value of equity as of the end of 2014?
A. $225 million
B. $3,833.0 million
C. $4,207.5 million
D. $4,365.0 million
E. $6,788.1 million
F. None of the above.

9-5
Chapter 09 - Business Valuation and Corporate Restructuring

8. The following table presents forecasted financial and other information for Scott's Miracle-
Gro Co.:

What is an appropriate estimate of Scott's terminal value as of the end of 2014, using a
warranted multiple of free cash flow as your estimate?
A. $155 million
B. $2,898.5 million
C. $3,007.0 million
D. $4,365.0 million
E. $7,042.2 million
F. None of the above.

9. Atmosphere, Inc. has offered $860 million cash for all of the common stock in ACE
Corporation. Based on recent market information, ACE is worth $710 million as an
independent operation. For the merger to make economic sense for Atmosphere, what would
the minimum estimated value of the enhancements from the merger have to be?
A. $0
B. $75 million
C. $150 million
D. $710 million
E. $860 million
F. None of the above.

9-6
Chapter 09 - Business Valuation and Corporate Restructuring

10. Consider the following premerger information about a bidding firm (Buyitall Inc.) and a
target firm (Tarjay Corp.). Assume that neither firm has any debt outstanding.

Buyitall has estimated that the present value of any enhancements that Buyitall expects from
acquiring Tarjay is $2,600. What is the NPV of the merger assuming that Tarjay is willing to
be acquired for $28 per share in cash?
A. $400
B. $600
C. $1,800
D. $2,200
E. $2,600
F. None of the above.

9-7
Chapter 09 - Business Valuation and Corporate Restructuring

Figure 9.1

In March of 2011, Macklemore Corp. considered an acquisition of Blue Scholar Learning,

Inc. (BSL), a privately-held educational software firm. As a first step in deciding what price to
bid for BSL, Macklemore's CFO, Ryan Lewis, has prepared a five-year financial projection
for the company assuming the acquisition takes place. Use this projection and BSL's 2010
actual financial figures to answer the questions below.

9-8
Chapter 09 - Business Valuation and Corporate Restructuring

11. What is BSL's free cash flow (in $ millions) for 2011?
A. - $938
B. - $792
C. - $7
D. $122
E. $1,091
F. None of the above.

12. Estimate the present value of BSL's free cash flow (in $ millions) for the years 2011 -
2015. Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of
the two companies' WACCs, weighted by sales, is 8.2 percent.
A. - $1.29
B. $628.24
C. $720.58
D. $726.68
E. $743.94
F. None of the above.

13. Estimate BSL's value (in $ millions) at the end of 2010 assuming it is worth the book
value of its assets at the end of 2015. Macklemore's WACC is 8.0 percent. BSL's WACC is
11.5 percent, and the average of the two companies' WACCs, weighted by sales, is 8.2
percent.
A. $628.24
B. $3,669.01
C. $4,297.25
D. $4,412.94
E. $4,984.28
F. $6,951.24
G. None of the above.

9-9
Chapter 09 - Business Valuation and Corporate Restructuring

14. Assume BSL is worth the book value of its assets at the end of 2015. Macklemore's
WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of the two companies'
WACCs, weighted by sales, is 8.2 percent. What is the maximum acquisition price (in $
millions) Macklemore should pay to acquire BSL's equity?
A. $1,702.25
B. $2,227.25
C. $2,342.94
D. $2,383.94
E. $2,603.25
F. $4,297.25
G. None of the above.

15. Estimate BSL's value (in $ millions) at the end of 2010 assuming that in the years after
2015 the company's free cash flow grows 4 percent per year in perpetuity. Macklemore's
WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of the two companies'
WACCs, weighted by sales, is 8.2 percent.
A. $4,297.25
B. $4,571.09
C. $4,686.78
D. $6,181.09
E. $5,351.19
F. $7,423.16
G. None of the above.

16. Assume that in the years after 2015 the company's free cash flow grows 4 percent per year
in perpetuity. Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the
average of the two companies' WACCs, weighted by sales, is 8.2 percent. What is the
maximum acquisition price (in $ millions) Macklemore should pay to acquire BSL's equity at
the end of 2010?
A. $1,976.09
B. $2,501.09
C. $2,877.09
D. $4,195.09
E. $4,571.09
F. None of the above.

9-10
Chapter 09 - Business Valuation and Corporate Restructuring

17. Estimate BSL's value (in $ millions) at the end of 2010 assuming that at year-end 2015 the
company's equity is worth 15 times earnings after tax and its debt is worth book value.
Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of the two
companies' WACCs, weighted by sales, is 8.2 percent.
A. $628.24
B. $3,669.01
C. $7,429.74
D. $6,343.26
E. $6,755.83
F. $7,008.06
G. None of the above.

18. Assume that at year-end 2015 the company's equity is worth 15 times earnings after tax
and its debt is worth book value. Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5
percent, and the average of the two companies' WACCs, weighted by sales, is 8.2 percent.
What is the maximum acquisition price (in $ millions) Macklemore should pay to acquire
BSL's equity at the end of 2010?
A. $3,484.68
B. $4,723.26
C. $4,938.06
D. $5,554.68
E. $6,343.26
F. None of the above.

9-11
Chapter 09 - Business Valuation and Corporate Restructuring

Short Answer Questions

19. The following information is available about Chiantivino Corp. (CC):

An activist investor is confident that by terminating CC's money-losing fortified wine

division, she can increase free cash flow by $4 million annually for the next decade. In
addition, she estimates that an immediate, special dividend of $10 million can be financed by
the sale of the division.

a. Assuming these actions do not affect CC's cost of capital, what is the maximum price per
share the investor would be justified in bidding for control of CC? What percentage premium
does this represent?
b. Show your answer if you conduct a sensitivity analysis by assuming the cost of capital is 15
percent and the increased cash flow is only $3.5 million per year.

9-12
Chapter 09 - Business Valuation and Corporate Restructuring

20. Below is a recent income statement for Gatlin Camera:

Calculate Gatlin's free cash flow in this year assuming it spent $510 on new capital equipment
and increased current assets net of noninterest-bearing current liabilities $340.

The following table presents a four-year forecast for Kenmore Air, Inc.:

9-13
Chapter 09 - Business Valuation and Corporate Restructuring

21. Estimate the fair market value of Kenmore Air at the end of 2012. Assume that after 2016,
earnings before interest and tax will remain constant at $200 million, depreciation will equal
capital expenditures in each year, and working capital will not change. Kenmore Air's
weighted-average cost of capital is 11 percent and its tax rate is 40 percent.

22. Estimate the fair market value per share of Kenmore Air's equity at the end of 2016 if the
company has 40 million shares outstanding and the market value of its interest-bearing
liabilities on the valuation date equals $250 million.

23. Estimate the fair market value of Kenmore Air's equity per share at the end of 2012 under
the following assumptions:

a. EBIT in year 2016 is $200 million, and then grows at 5 percent per year forever.
b. To support the perpetual growth in EBIT, capital expenditures in year 2017 exceed
depreciation by $30 million, and this difference grows 5 percent per year forever.
c. Similarly, working capital investments are $15 million in 2017, and this amount grows 5
percent per year forever.

9-14
Chapter 09 - Business Valuation and Corporate Restructuring

24. Estimate the fair market value of Kenmore Air's equity per share at the end of 2012 under
the following assumptions:

a. EBIT in year 2016 will be $200 million.

b. At year-end 2016, Kenmore Air has reached maturity, and analysts expect its equity will
sell for 12 times year 2016 net income.
c. At year-end 2016, Kenmore Air has $250 million of interest-bearing liabilities outstanding
at an average interest rate of 10 percent.

25. Ametek, Inc. is a billion dollar manufacturer of electronic instruments and motors
headquartered in Paoli, Pennsylvania. Use the following information on Ametek and five
other similar companies to value Ametek, Inc. on December 31, 2010.

9-15
Chapter 09 - Business Valuation and Corporate Restructuring

9-16
Chapter 09 - Business Valuation and Corporate Restructuring

*American Power Conversion has no interest-bearing debt outstanding.

MV = Market value; BV = Book value. Market value is estimated as book value of interest-
bearing debt + market value of equity. Earnings are fiscal year earnings.

26. Rainy City Coffee's (RCC) free cash flow next year will be $100 million and it is expected
to grow at a 4 percent annual rate indefinitely. The company's weighted average cost of
capital is 10 percent, the market value of its liabilities is $1 billion, and it has 20 million
shares outstanding.

a. Estimate the price per share of RCC's common stock.

b. A hedge fund believes that by selling the company's private jet and instituting other cost
savings, it can increase RCC's free cash flow next year to $110 million and can add a full
percentage point to RCC's growth rate without affecting its cost of capital. What is the
maximum price per share the hedge fund can justify bidding for control of RCC?

27. Empirical evidence indicates that the returns to shareholders of the target firm vary
significantly from the returns to the shareholders of the acquiring firm. Identify the
shareholders that tend to realize the smaller return. Does your answer depend on the way the
acquisition is financed?

9-17
Chapter 09 - Business Valuation and Corporate Restructuring

Chapter 09 Business Valuation and Corporate Restructuring Answer Key

Multiple Choice Questions

1. Which of the following statements are correct?

I. Liquidation value of a firm is equal to the present worth of expected future cash flows from
operating activities.
II. When an acquiring firm purchases a target firm's equity, the acquirer must assume the
target's liabilities.
III. The market value of a public company reflects the worth of the business to minority
investors.
IV. The fair market value of a business is usually the lower of its liquidation value and its
going-concern value.
A. I and III only
B. II and IV only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
F. None of the above.

Difficulty: 2 Medium

9-18
Chapter 09 - Business Valuation and Corporate Restructuring

2. Ginormous Oil entered into an agreement to purchase all of the outstanding shares of Slick
Company for $60 per share. The number of outstanding shares at the time of the
announcement was 82 million. The book value of liabilities on the balance sheet of Slick Co.
was $1.46 billion. What was the cost of this acquisition to the shareholders of Ginormous
Oil?
A. $1.46 billion
B. $3.46 billion
C. $4.92 billion
D. $6.38 billion
E. $8.38 billion
F. None of the above.

The value of the bid to Ginormous's shareholders is the value of the assets acquired in the
merger. This would include the value of the equity acquired and the liabilities that accompany
the equity. Therefore, the cost of the acquisition was ($60 x 82 million shares) + $1.46 billion
= 6.38 billion.

Difficulty: 1 Easy

3. Ginormous Oil entered into an agreement to purchase all of the outstanding shares of Slick
Company for $60 per share. The number of outstanding shares at the time of the
announcement was 82 million. The book value of liabilities on the balance sheet of Slick Co.
was $1.46 billion. Immediately prior to the Ginormous Oil bid, the shares of Slick Co. traded
at $33 per share. What value did Ginormous Oil place on the control of Slick Co.?
A. $2.21 billion
B. $2.71 billion
C. $4.17 billion
D. $6.38 billion
E. None of the above.

The cost of the acquisition, or value of the bid, was ($60 x 82 million shares) + $1.46 billion =
6.38 billion. The value of the control of Slick Co. is the difference in value between the bid
and the market value prior to the bid. The market value prior to the bid was ($33 x 82 million)
+ $1.46 billion = $4.166 billion. Thus, the value of control was 6.38 - 4.166 = $2.214 billion.

Difficulty: 1 Easy

9-19
Chapter 09 - Business Valuation and Corporate Restructuring

4. Which of the following statements is/are correct?

I. Going-concern value of a firm is equal to the present value of expected net income.
II. When a buyer values a target firm, the appropriate discount rate is the buyer's weighted-
average cost of capital.
III. The liquidation value estimate of terminal value usually vastly understates a healthy
company's terminal value.
IV. The value of a firm's equity equals the discounted cash flow value of the firm minus all
liabilities.
A. II only
B. III only
C. I and II only
D. II and III only
E. II, III, and IV only
F. None of the above.

Difficulty: 2 Medium

5. Which of the following statements are correct?

I. Going-concern value of a firm is equal to the present value of expected future cash flows to
owners and creditors.
II. When an acquiring firm purchases a target firm's equity, the acquirer need not assume the
target's liabilities.
III. The market value of a public company reflects the worth of the business to minority
investors.
IV. The fair market value of a business is usually the lower of its liquidation value and its
going-concern value.
A. I and III only
B. II and IV only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
F. None of the above.

Difficulty: 2 Medium

9-20
Chapter 09 - Business Valuation and Corporate Restructuring

6. The following table presents forecasted financial and other information for Scott's Miracle-
Gro Co.:

What is an appropriate estimate of Scott's terminal value as of the end of 2014, using the
perpetual-growth equation as your estimate?
A. $161 million
B. $363 million
C. $3,690 million
D. $3,838 million
E. $5,357 million
F. None of the above.

FCF2015 = 155* (1 + .04) = 161 million.

Terminal value2014 = FCF2015/KW - g = $161 million/0.082 - .04 = $3,833 million.

Difficulty: 2 Medium

9-21
Chapter 09 - Business Valuation and Corporate Restructuring

7. The following table presents forecasted financial and other information for Scott's Miracle-
Gro Co.:

What is an appropriate estimate of Scott's terminal value of equity as of the end of 2014?
A. $225 million
B. $3,833.0 million
C. $4,207.5 million
D. $4,365.0 million
E. $6,788.1 million
F. None of the above.

Terminal value2014 = 18.7*$225 million = $4,207.5 million.

Difficulty: 2 Medium

9-22
Chapter 09 - Business Valuation and Corporate Restructuring

8. The following table presents forecasted financial and other information for Scott's Miracle-
Gro Co.:

What is an appropriate estimate of Scott's terminal value as of the end of 2014, using a
warranted multiple of free cash flow as your estimate?
A. $155 million
B. $2,898.5 million
C. $3,007.0 million
D. $4,365.0 million
E. $7,042.2 million
F. None of the above.

Terminal value2014 = 19.4*$155 million = $3,007.0 million.

Difficulty: 1 Easy

9-23
Chapter 09 - Business Valuation and Corporate Restructuring

9. Atmosphere, Inc. has offered $860 million cash for all of the common stock in ACE
Corporation. Based on recent market information, ACE is worth $710 million as an
independent operation. For the merger to make economic sense for Atmosphere, what would
the minimum estimated value of the enhancements from the merger have to be?
A. $0
B. $75 million
C. $150 million
D. $710 million
E. $860 million
F. None of the above.

Minimum economic value in PV terms = $860 million - $710 million = $150 million

Difficulty: 1 Easy

9-24
Chapter 09 - Business Valuation and Corporate Restructuring

10. Consider the following premerger information about a bidding firm (Buyitall Inc.) and a
target firm (Tarjay Corp.). Assume that neither firm has any debt outstanding.

Buyitall has estimated that the present value of any enhancements that Buyitall expects from
acquiring Tarjay is $2,600. What is the NPV of the merger assuming that Tarjay is willing to
be acquired for $28 per share in cash?
A. $400
B. $600
C. $1,800
D. $2,200
E. $2,600
F. None of the above.

The NPV of the merger is the market value of the target firm, plus the value of the
enhancements, minus the acquisition costs: NPV = 1,100 ($26) + $2,600 - 1,100($28) = $400.

Difficulty: 1 Easy

9-25
Chapter 09 - Business Valuation and Corporate Restructuring

Figure 9.1

In March of 2011, Macklemore Corp. considered an acquisition of Blue Scholar Learning,

Inc. (BSL), a privately-held educational software firm. As a first step in deciding what price to
bid for BSL, Macklemore's CFO, Ryan Lewis, has prepared a five-year financial projection
for the company assuming the acquisition takes place. Use this projection and BSL's 2010
actual financial figures to answer the questions below.

9-26
Chapter 09 - Business Valuation and Corporate Restructuring

11. What is BSL's free cash flow (in $ millions) for 2011?
A. - $938
B. - $792
C. - $7
D. $122
E. $1,091
F. None of the above.

(NOTE to instructor: for this question, you might choose to remove the last row of Figure
9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = -$7.

Difficulty: 2 Medium

9-27
Chapter 09 - Business Valuation and Corporate Restructuring

12. Estimate the present value of BSL's free cash flow (in $ millions) for the years 2011 -
2015. Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of
the two companies' WACCs, weighted by sales, is 8.2 percent.
A. - $1.29
B. $628.24
C. $720.58
D. $726.68
E. $743.94
F. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

The fundamental principle is that the discount rate should reflect the risks of the cash flows
discounted. Here, the cash flows are BSL's, so BSL's WACC is the appropriate discount rate.
Some argue incorrectly that because BSL will disappear in the merger, the cash flows will
become Macklemore's, so Macklemore's WACC is the appropriate discount rate. However, the
relevant criterion is the risk of the cash flows, not who owns them or what we call them.

Difficulty: 3 Hard

9-28
Chapter 09 - Business Valuation and Corporate Restructuring

13. Estimate BSL's value (in $ millions) at the end of 2010 assuming it is worth the book
value of its assets at the end of 2015. Macklemore's WACC is 8.0 percent. BSL's WACC is
11.5 percent, and the average of the two companies' WACCs, weighted by sales, is 8.2
percent.
A. $628.24
B. $3,669.01
C. $4,297.25
D. $4,412.94
E. $4,984.28
F. $6,951.24
G. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

Terminal value in 2015 = $6,323.00. PV@ 11.5% {Terminal value, 5 years} = 3,669.01.
Estimated firm value = $628.24 + 3,669.01 = $4,297.25

Difficulty: 3 Hard

9-29
Chapter 09 - Business Valuation and Corporate Restructuring

14. Assume BSL is worth the book value of its assets at the end of 2015. Macklemore's
WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of the two companies'
WACCs, weighted by sales, is 8.2 percent. What is the maximum acquisition price (in $
millions) Macklemore should pay to acquire BSL's equity?
A. $1,702.25
B. $2,227.25
C. $2,342.94
D. $2,383.94
E. $2,603.25
F. $4,297.25
G. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

Terminal value in 2015 = $6,323.00. PV@ 11.5% {Terminal value, 5 years} = 3,669.01.
Estimated firm value = $628.24 + 3,669.01 = $4,297.25
Equity value = firm value - existing interest-bearing debt = $4,297.25 - (335 + 41 + 1694) =
$2,227.25

Difficulty: 3 Hard

9-30
Chapter 09 - Business Valuation and Corporate Restructuring

15. Estimate BSL's value (in $ millions) at the end of 2010 assuming that in the years after
2015 the company's free cash flow grows 4 percent per year in perpetuity. Macklemore's
WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of the two companies'
WACCs, weighted by sales, is 8.2 percent.
A. $4,297.25
B. $4,571.09
C. $4,686.78
D. $6,181.09
E. $5,351.19
F. $7,423.16
G. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

Terminal value in 2015 = (490*(1 + 0.04))/(0.115 - 0.04) = $6,794.92; PV@ 11.5% {Terminal
value, 5 years} = 3,942.85
Estimated firm value = $628.24 + 3,942.85 = $4,571.09

Difficulty: 3 Hard

9-31
Chapter 09 - Business Valuation and Corporate Restructuring

16. Assume that in the years after 2015 the company's free cash flow grows 4 percent per year
in perpetuity. Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the
average of the two companies' WACCs, weighted by sales, is 8.2 percent. What is the
maximum acquisition price (in $ millions) Macklemore should pay to acquire BSL's equity at
the end of 2010?
A. $1,976.09
B. $2,501.09
C. $2,877.09
D. $4,195.09
E. $4,571.09
F. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

Terminal value in 2015 = (490*(1 + 0.04))/(0.115 - 0.04) = $6,794.92; PV@ 11.5% {Terminal
value, 5 years} = 3,942.85
Estimated firm value = $628.24 + 3,942.85 = $4,571.09
Equity value = firm value - existing interest-bearing debt = $4,571.09 - (335 + 41 + 1694) =
$2,501.09

Difficulty: 3 Hard

9-32
Chapter 09 - Business Valuation and Corporate Restructuring

17. Estimate BSL's value (in $ millions) at the end of 2010 assuming that at year-end 2015 the
company's equity is worth 15 times earnings after tax and its debt is worth book value.
Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5 percent, and the average of the two
companies' WACCs, weighted by sales, is 8.2 percent.
A. $628.24
B. $3,669.01
C. $7,429.74
D. $6,343.26
E. $6,755.83
F. $7,008.06
G. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

Terminal value in 2015 = value of equity + value of debt = 15*566 + (393 + 267 + 699) =
8490 + 1359 = $9,849; PV@ 11.5% {Terminal value, 5 years} = $5,715.02
Estimated firm value = $628.24 + $5,715.02 = $6,343.26

Difficulty: 3 Hard

9-33
Chapter 09 - Business Valuation and Corporate Restructuring

18. Assume that at year-end 2015 the company's equity is worth 15 times earnings after tax
and its debt is worth book value. Macklemore's WACC is 8.0 percent. BSL's WACC is 11.5
percent, and the average of the two companies' WACCs, weighted by sales, is 8.2 percent.
What is the maximum acquisition price (in $ millions) Macklemore should pay to acquire
BSL's equity at the end of 2010?
A. $3,484.68
B. $4,723.26
C. $4,938.06
D. $5,554.68
E. $6,343.26
F. None of the above.

(NOTE to instructor: for this question, you might choose to include the FCF for 2011 of - $7
in the last row of Figure 9.1.)
FCF = EBIT(1 - Tax rate) + Depreciation - Capital expenditures - Working capital investment.
EBIT = Income before tax + Interest = 323 + 178 = $501.
Tax rate = 126/323 = .390 or 39.0%
Capital expenditures = change in Gross Property and Equipment = 5139 - 4180 = 969
Change in working capital: working capital is Current Assets less operating Current Liabilities
—this excludes Short-term debt and Current portion of long-term debt. Hence, the Working
Capital balance is 1234 - (77 + 97) = 1060 in 2011, and 931 in 2010. The change in working
capital is 1060 - 931 = 129; this increase is a cash outflow.
Thus, 2011 Free Cash Flow = 501(1 - .39) + 785 - 969 - 129 = - $7.

PV@ 11.5% {FCFs, 2011 - 2015} = $628.24

Terminal value in 2015 = value of equity + value of debt = 15*566 + (393 + 267 + 699) =
8490 + 1359 = $9,849; PV@ 11.5% {Terminal value, 5 years} = $5,715.02
Estimated firm value = $628.24 + $5,715.02 = $6,343.26
Equity value = firm value - existing interest-bearing debt = $6,343.26 - (335 + 41 + 1694) =
$4,723.26

Difficulty: 3 Hard

9-34
Chapter 09 - Business Valuation and Corporate Restructuring

Short Answer Questions

19. The following information is available about Chiantivino Corp. (CC):

An activist investor is confident that by terminating CC's money-losing fortified wine

division, she can increase free cash flow by $4 million annually for the next decade. In
addition, she estimates that an immediate, special dividend of $10 million can be financed by
the sale of the division.

9-35
Chapter 09 - Business Valuation and Corporate Restructuring

a. Assuming these actions do not affect CC's cost of capital, what is the maximum price per
share the investor would be justified in bidding for control of CC? What percentage premium
does this represent?
b. Show your answer if you conduct a sensitivity analysis by assuming the cost of capital is 15
percent and the increased cash flow is only $3.5 million per year.

a. The maximum justifiable premium = the fair market value of CC under new management -
the fair market value of CC under existing management. A plausible estimate of CC's fair
market value under existing management is its standalone value = current market value of
firm = $8 x 10 million + 75 million = $155 million.
Fair market value under new management = $155 million + present value of enhancements =
$155 million + present value of a $4 million annuity for 10 years at 14% + $10 million from
sale of the division.
b. Fair market value = $155 million + $4 million x 5.216 + $10 million = $185.86. Fair
market value of equity = $185.86 - 75 = $110.86. Fair market of equity per share =
$110.86/10 = $11.09. This is a 38.6% premium over the existing $8 share price.

Fair market value of the firm assuming a 15 percent discount rate and a $3.5 million annuity =
155 + 3.5(5.019) + 10 = $182.57 million. Value of equity = 182.57 - 75 = 107.57. Value per
share = 107.57/10 = $10.76. This is a 34.5% premium over the existing price.

Difficulty: 2 Medium

9-36
Chapter 09 - Business Valuation and Corporate Restructuring

20. Below is a recent income statement for Gatlin Camera:

Calculate Gatlin's free cash flow in this year assuming it spent $510 on new capital equipment
and increased current assets net of noninterest-bearing current liabilities $340.

Free cash flow = EBIT(1 - Tax rate) + Depreciation - Fixed investment - Working capital
investment.
EBIT = Income before tax + Interest = 1,800 + 570 = $2,370.
Tax rate = 612/1,800 = .34
Free cash flow = 2,370(1 - .34) + 800 - 510 - 340 = $1,514.20.

Difficulty: 2 Medium

The following table presents a four-year forecast for Kenmore Air, Inc.:

9-37
Chapter 09 - Business Valuation and Corporate Restructuring

21. Estimate the fair market value of Kenmore Air at the end of 2012. Assume that after 2016,
earnings before interest and tax will remain constant at $200 million, depreciation will equal
capital expenditures in each year, and working capital will not change. Kenmore Air's
weighted-average cost of capital is 11 percent and its tax rate is 40 percent.

FMV = PV{FCF, 2013 - 16} + PV{Terminal value}. Discounting the FCFs at an 11 percent
cost of capital, PV{FCF, 2013 - 16} = $155.9 million. Terminal value = EBIT(1 - Tax
rate)/0.11 = $120/0.11 = $1090.9 million. PV{Terminal value} = $1090.9 million/(1 + 0.11)4
= $718.6 million. Summing, FMV = $874.5 million.

Difficulty: 2 Medium

22. Estimate the fair market value per share of Kenmore Air's equity at the end of 2016 if the
company has 40 million shares outstanding and the market value of its interest-bearing
liabilities on the valuation date equals $250 million.

FMV = PV{FCF, 2013 - 16} + PV{Terminal value}. Discounting the FCFs at an 11 percent
cost of capital, PV{FCF, 2013 - 16} = $155.9 million. Terminal value = EBIT(1 - Tax
rate)/0.11 = $120/0.11 = $1090.9 million. PV{Terminal value} = $1090.9 million/(1 + 0.11)4
= $718.6 million. Summing, FMV = $874.5 million.
FMV of equity = ($874.5 - $250)/40 = $15.61 per share.

Difficulty: 2 Medium

9-38
Chapter 09 - Business Valuation and Corporate Restructuring

23. Estimate the fair market value of Kenmore Air's equity per share at the end of 2012 under
the following assumptions:

a. EBIT in year 2016 is $200 million, and then grows at 5 percent per year forever.
b. To support the perpetual growth in EBIT, capital expenditures in year 2017 exceed
depreciation by $30 million, and this difference grows 5 percent per year forever.
c. Similarly, working capital investments are $15 million in 2017, and this amount grows 5
percent per year forever.

FMV = PV{FCF, 2013 - 16} + PV{Terminal value}. Discounting the FCFs at an 11 percent
cost of capital, PV{FCF, 2013 - 16} = $155.9 million. Terminal value = FCF in 2017/(0.11 -
0.05). FCF in 2017 = $200(1.05)(1 - .4) - 30 - 15 = $81. So, terminal value = $81/(.11 - .05) =
$1,350. Present value of terminal value = $889.3. FMV of company = $155.9 + $889.3 =
$1,045.2 million. FMV of equity per share = ($1,045.2 - $250)/40 = $19.88

Difficulty: 3 Hard

24. Estimate the fair market value of Kenmore Air's equity per share at the end of 2012 under
the following assumptions:

a. EBIT in year 2016 will be $200 million.

b. At year-end 2016, Kenmore Air has reached maturity, and analysts expect its equity will
sell for 12 times year 2016 net income.
c. At year-end 2016, Kenmore Air has $250 million of interest-bearing liabilities outstanding
at an average interest rate of 10 percent.

FMV = PV{FCF, 2013 - 16} + PV{Terminal value}. Discounting the FCFs at an 11 percent
cost of capital, PV{FCF, 2013 - 16} = $155.9 million. Terminal value = Value of equity +
Value of interest-bearing liabilities. Value of equity = 12 x Net income in 2012 = 12 x (200 -
0.10 x 250)(1 - .40) = $1,260 million. Terminal value = $1,260 million + $250 million =
$1,510. Present value of terminal value = $994.7. Therefore, the FMV of company on
valuation date = $155.8 + $994.7 = $1,150.6 million. Value per share = ($1,150.6 million -
$250 million)/40 = $22.51.

Difficulty: 3 Hard

9-39
Chapter 09 - Business Valuation and Corporate Restructuring

25. Ametek, Inc. is a billion dollar manufacturer of electronic instruments and motors
headquartered in Paoli, Pennsylvania. Use the following information on Ametek and five
other similar companies to value Ametek, Inc. on December 31, 2010.

9-40
Chapter 09 - Business Valuation and Corporate Restructuring

*American Power Conversion has no interest-bearing debt outstanding.

MV = Market value; BV = Book value. Market value is estimated as book value of interest-
bearing debt + market value of equity. Earnings are fiscal year earnings.

9-41
Chapter 09 - Business Valuation and Corporate Restructuring

The median and mean values for Ametek's peers are presented below:

The following estimates require subjective reasoning. In coming to these estimates, Ametek,
Inc. (AI) is judged as exhibiting representative earnings per share growth, but considerably
higher financial leverage, and a below-average five-year growth rate in sales.
The company's higher-than-average leverage suggests that its firm value ratios will be
particularly key, as equity value ratios can be distorted by Ametek's higher leverage. Since the
firm value ratios abstract from differences in financing, values for these ratios are selected
that are closer to the sample averages. Turning to equity value ratios, AI's modest growth and
higher financial leverage suggest a 10 to 20 percent discount from the group average for its
price/earnings and price/sales indicators.
Here are estimated indicators of value for Ametek, Inc.

9-42
Chapter 09 - Business Valuation and Corporate Restructuring

The implied value of AI common stock per share for each indicator of value is:

A best guess of a fair price for Ametek, Inc.'s shares at year-end 2010 is $36.00. Many other
estimates are, of course, possible.

Difficulty: 3 Hard

9-43
Chapter 09 - Business Valuation and Corporate Restructuring

26. Rainy City Coffee's (RCC) free cash flow next year will be $100 million and it is expected
to grow at a 4 percent annual rate indefinitely. The company's weighted average cost of
capital is 10 percent, the market value of its liabilities is $1 billion, and it has 20 million
shares outstanding.

a. Estimate the price per share of RCC's common stock.

b. A hedge fund believes that by selling the company's private jet and instituting other cost
savings, it can increase RCC's free cash flow next year to $110 million and can add a full
percentage point to RCC's growth rate without affecting its cost of capital. What is the
maximum price per share the hedge fund can justify bidding for control of RCC?

Price per share of RCC stock = (100/(.10 - .04) - 1,000)/20 = $33.33.

Fair market value of equity per share after change in ownership = (110/(.10 - .05) - 1,000)/20
= $60.00.

Difficulty: 2 Medium

27. Empirical evidence indicates that the returns to shareholders of the target firm vary
significantly from the returns to the shareholders of the acquiring firm. Identify the
shareholders that tend to realize the smaller return. Does your answer depend on the way the
acquisition is financed?

The empirical evidence strongly indicates that the shareholders of the target firm realize large
wealth gains (premiums of 20 - 40 percent) as a result of a takeover bid but the shareholders
in the acquiring firm gain little or nothing. While a definitive answer is elusive, the following
have been offered as possible explanations for these low returns to acquiring shareholders:
size differentials, competition in the takeover market, lack of achieving expected synergy
gains, management goals other than the best interests of the shareholders, and early
announcements of corporate acquisition intent.

The empirical evidence also suggests that leveraged buyouts lead to sizeable improvements in
operating performance and attractive returns to buyers. Hence, financing policy does appear
to change the outcome for buyers.

Difficulty: 1 Easy

9-44