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Chapter 20 - Management Compensation, Business Analysis, and Business Valuation
20-53 (continued -1)
A financial ratio analysis of BPP’s liquidity shows a company that is
improving quite well on all measures. The receivables turnover and
inventory turnover ratios are both significantly better than the industry
BPP’s cash flow relative to current liabilities has also improved
significantly from 2015 to 2016 though both cash flow ratios are less than
the industry average. The main reason for the improvement in cash flow
is the significant decrease in receivables and inventory; the company
employed much improved methods for managing these assets over the last
year (note we have assumed for simplicity that the balances of all
As to profitability, BPP’s ratios have improved significantly from 2015
to 2016. However, return on assets is still lower than the industry
average, while return on equity is not substantially higher than the industry
average. Contributing factors include the relatively low gross margin
20-47
Education.
Chapter 20 - Management Compensation, Business Analysis, and Business Valuation
20-48 Business Valuation (30 min)
1. & 2. Calculation of book value, market value, discounted cash flow, and
multiples-based values:
3. The six measures provide a wide range of valuations, from a low of
$125,941,338 for the book value of equity to a high of $1,583,682,481 for
the discounted cash flow method. The discounted cash flow measure is
relatively high because of the significant increase in cash flow in 2016 due
based on current earnings, cash flows, and sales relative to the industry
average multiples. Putting the end points of the range aside, a
conservative estimate of the company’s value should be close to
$919,172,242, the market value of the firm based on the current market
share price.
4. If the company is valued at approximately $919,172,242, this would
reflect an expected share price close to its current market value of $35.78.
Thus, the $38 offer looks good. On the other hand, if one projects a
continued high level of free cash flow in the coming years, then since the
20-48
Education.
20.54 (continued - 1)
5. Sustainability issues may arise in the acquisition because both GSI and
BPP operate in environmentally sensitive industries. GSI, a retailer of
gardening supplies, must be vigilant about both the manufacturing
practices of its suppliers (to minimize harmful waste products getting into
Also, the use of BPP plumbing expertise and materials has a sustainability
dimension. If these products are used to supply home or commercial lawn
and garden watering systems, then for sustainability, the systems must be
designed to use water as efficiently as possible, so that little water is
wasted. Also, if the BPP organization uses its expertise and materials to
design drainage systems for homes and commercial property, then these
drainage systems must be such that and harmful waste materials are not
allowed to pollute nearby fields and streams.
Given that many investors now consider sustainability and important part of
a company’s strategic planning, then valuation will also be affected by
whether or not a company such as GSI or BPP have a sustainability plan.
Sustainability efforts are also often tied to cost reduction, as the company’s
Chapter 20 - Management Compensation, Business Analysis, and Business Valuation
20-55 Research Assignment; Business Valuation (50 min)
1. The authors make the point that a successful business strategy expert
must be a very competent business valuation expert, and vice versa,
and thus, the roles of the two converge. For example, a business
valuation expert who does not fully understand the company’s strategy
2. The authors cite their research and include example companies to show
that a great product does not necessarily produce a great, valuable
company. The key is the competitive environment and the customer
needs. There may be competitors that supply the same great product
but at a better price or better customer service. Or alternatively, the
3. The explanation here follows that in part 2 above. That is, the
“differences” have to be those differences that the customers are willing
4. The explanation here follows from the above. A great product does not
mean a great company and a great company does not mean a great
stock. A great stock is one for which investors see a relatively certain
and positive direction in earnings and, particularly, cash flows.
Investors may see for example the same level of cash flows in Company
A as in Company B in the current year, but have different expectations
Price-Earnings ratio, or “earnings multiple” as explained in the chapter.
20-55 (continued -1)
20-50
Education.
5. Substantial growth can lead to financial difficulties, as can be seen in the
poor financial performance of many financial and construction firms’
since 2007. The basic idea is that the increase in assets or revenues
