Corporate Finance Juan Carlos Ganme Gerardo Fumagal Osvaldo Gallegos Cases: Marriott A and Flinder Valves

Case Marriott A Questions to solve: 1. Why is Marriotts CFO proposing the Project Chariot? To improve the financial performance of the firm, by re-structuring the company in two separating activities to distinguish those that require a large fixed assets (Real estates ownership) and those with relative low amount of assets (Management services and others). By dividing in this way, the large amount of debt will go with the real estates ownership called Host Marriott Corp. (HMC), whereas the rest of activities will go to Marriott International (MII). Doing so, the value of the 2 firms combined will exceed this years book value, according to expectations (see appendix 1). 2. Is the proposed restructuring consistent with managements responsibilities? It is, as it clearly separate the activities and focus on management services rather than owning the hotels. Furthermore, it improves the cash flows from the existing structure (see appendix 1), this improvement will allow HMC to meet its debt responsibilities ( a total cash flow projected of $771 million in 1992 versus $478 million in 1991. The DCF in HMC assuming a worst case scenario will exceed current value of the firms assets $5,218 million versus $4,600 million, which indicates that the firm will improve as its assets will appreciate. 3. The case describes two conceptions of managers fiduciary duty (page 9). Which do you favor: the shareholder conception or the corporate conception? Does your stance make a difference in this case? We agree upon favoring the shareholder conception, as this provides an improvement on cash flows, as this condition is met, other financial gaps can be covered, plus it revalues the total firm based upon the expected cash flows. In this particular case, by having this improvement on cash flow, debt responsibilities can be covered inside HMC or by using the line of credit guaranteed by MII. On regards of the bondholders, the option is to increase the return as bonds will reduce the grade to junk bonds, for the calculation on DCF we assume a return of 10.81 assuming the highest risk for bonds. This action will compensate bondholders for the action. 4. Should Mr. Marriott recommend the proposed restructuring to the board?

Yes, as it increase the value of the combined firms, focus activities per company and provides better cash flows.

Appendix 1.
Marriott A 1989 1990 1991 Forecast 1992 Notes

MC Long-term debt Total shareholder's equity Book Value Sales Growth Share Price EPS Dividends Ke Kd WACC HMC Long-term debt D Total shareholder's equity E Sales Operating cash flow before corporate expenses, interest expenses and taxes Total Assests Ke Kd WACC DCF 2,000 600 1,800 363 4,600 10.70% 10.81% 7.96% 5,218 7,536 14% 33.38 1.62 0.25 D E 3598 407 4005 7,646 1% 10.50 0.46 0.28 2979 679 3658 8,331 9% 16.50 0.80 0.28 10.70% 9.30% 8.01%

Using the dividend formula (DIV/Po)+g

Assuming the worst case scenario growth as in 1990

Book Value MIC Long-term debt D Total shareholder's equity E Sales Operating cash flow before corporate expenses, interest expenses and taxes Book Value Combined Value

2600

400 800 7900 408

1200 3800

Case Flinder Valves and Controls Questions to solve: 5. How do you see FVCs situation? What are the strengths and weaknesses of FVC and RSE? Why should the two companies want to negotiate? FVC is about to embark in a project with high risk, that involves a technology not yet probed to be deployed. Its financial structure is based on pure equity to finance its operations. The ratio analysis shown that the margins of FVC are quite lower in comparison with those from RSE, 74 % in average fro FVC and 28 % in average for RSE. This represents and advantage for FVC in case of the merger, as more cash can fund their projects especially in the case of high risk is associated. FVC has appreciate on its stock value on the last 3 year growing from 22.25 to 39.75 increasing the equity of the company, this is an advantage for RSE to make the merger, RSE has sustained its stock value on the last years, so the opportunity to buy FVC is to improve its stock value. RSE has a capital structure balanced between debt and equity, more flexible that FVC a 14 % debt from capital is presented in 2007. RSE WACC is on 24.4 % and tends to lower as prediction on stock price will improve the value lowering the cost of equity since dividend will remain. The companies should merge, as benefits to promote project are clear, their numbers will improve WACC is lower and cash will increase to fund the high risk projects. 6. What is FVC worth? What are the key value drivers? FVC value according to DFC method worth 75 million, although, by using the industrys average the value seems to be higher more than 103 million which is closer to the market capitalization given in the case. The difference can be explain by the capital structure of the firm as it does not have debt the WACC is higher so is the discount rate, with more debt the discount is lower the value will increase. FVC is a firm based on high skilled engineers that develop contractual work for machinery industry; FVC strives for innovation and technology. We do not know about the cycle of product development on this industry but that has to be a driver in order to decide the capital structure

Appendix 2.
FVC

2007
DCF Value WACC CFA =EBIT*(1-Tc)+Depreciation exp - WCR - Net capital exp

2008
3.3% $1,580

2009

2010

2011

2012

$5,310

$5,784

Residual value of assets DCF value of =NPV(WACC,CFAi)+residual assets value of assets Value of Assets By comparables: Price-earnings ratio Estimated value Average of Industry =EAT*PE ratio 18.55 $103,416

$6,428 $ 51,414

$7,249

$75,004

FVC Ratios ROE RSM ROE Debt % Ke Kd WACC =EAT/Equity 17% 14% 18.9% 7.76% 24.24% 14% 7.2% 6.98% 9.59% =EAT/Equity 15%