Valuation
Measuring and Managing the Value of Companies
5th Edition
Chapter 6 Solutions
Frameworks for Valuation
Version 1.0
April 1, 2010
Chapter 6
Question 1
Income Statement Reorganized balance sheet Free cash flow
Today Year 1 Today Year 1 Year 1
Revenues 800.0 840.0 Operating working capital 70.1 73.6 Operating profits 126.0
Operating costs (640.0) (672.0) Property and equipment 438.4 460.3 Operating taxes (31.5)
Depreciation (40.0) (42.0) Invested capital 508.5 533.9 NOPLAT 94.5
Operating profits 120.0 126.0
Debt 200.0 210.0 Depreciation 42.0
Interest (16.0) (16.0) Shareholders’ equity 308.5 323.9 Gross cash flow 136.5
Earnings before taxes 104.0 110.0 Invested capital 508.5 533.9
Increase in working capital (3.5)
Taxes (26.0) (27.5) Capital expenditures (63.9)
Net Income 78.0 82.5 Free cash flow 69.1
Key Data:
Operating tax rate 25% 25%
Chapter 6
Question 2
Equity value
Shares outstanding 50.0
x Share price 19.16
Equity value 958.2
Weighted average cost of capital
Proportion After-tax Contribution
Market of total Cost of Marginal cost of to weighted
Source of capital value capital capital tax rate capital average
Debt 200.0 17.3% 8.0% 25.0% 6.0% 1.0%
Equity 958.2 82.7% 12.0% 12.0% 9.9%
Enterprise Value 1,158.2 100.0% 11.0%
Commentary
The market value of debt will not equal book value if the company is distressed (i.e. the probability of default is meaningful) or
if interest rates have changed meaningfully since the debt was issued.
Chapter 6
Questions 3 & 4
Enterprise Valuation
Free cash flow 69.1
Cost of capital 11.0%
Expected growth 5.0%
Enterprise valuation 1,158.2
Equity Valuation
Enterprise valuation 1,158.2
Value of debt (200.0)
Equity value 958.2
Shares outstanding 50.0
Value per share 19.16
Chapter 6
Questions 5 & 6
Economic profit Economic profit valuation
Year 1 PV (economic profit) Year 1
Operating profit 126.0 Economic profit 38.7
Operating taxes (31.5) Cost of capital 11.0%
NOPLAT 94.5 Growth 5.0%
PV (economic profit) 649.7
Invested capital today 508.5
x Cost of capital 11.0% Enterprise value
Capital charge 55.8
Invested capital today 508.5
PV (economic profit) 649.7
Economic profit 38.7 Enterprise value 1,158.2
DCF value 1,158.2
As can be seen by comparing enterprise value in Question 6 with that of Question 4, the two values are identical (as expected).
More commentary on Question 6
where RONIC is the return on on new capital.
Unless the firm has some sustainable competitive advantage, ROIC=WACC.
$859.09
This is an estimate of enterprise value.
If done correctly, the estimate using this method should equal that using the DCF method.
Chapter 6
Question 7
Cash flow to equity Direct equity valuation
Net income 82.5 Cash flow to equity 67.1
Depreciation 42.0 Cost of equity 12.0%
Gross cash flow 124.5 Growth rate 5.0%
Equity valuation 958.2
Increase in working capital (3.5)
Capital expenditures (63.9)
Increase in debt 10.0
Cash flow to equity 67.1
EXHIBIT 6.18 BrandCo: Income Statement and Reorganized Balance Sheet
$ million
Income Statement Today Year 1 Reorganized balance sheet Today Year 1
Revenues 800.0 840.0
Operating working capital170.1 73.6
Operating costs (640.0) (672.0) Property and equipment 438.4 460.3
Depreciation (40.0) (42.0) Invested capital 508.5 533.9
Operating profits 120.0 126.0
Debt 200.0 210.0
Interest (16.0) (16.0) Shareholders‘ equity 308.5 323.9
Earnings before taxes 104.0 110.0 Invested capital 508.5 533.9
Taxes (26.0) (27.5)
Net Income 78.0 82.5
1 Accounts payable has been netted against inventory to determine operating working capital
Exhibit Data:
Income Statement Today Year 1 Balance sheet Today Year 1
Growth in revenues n/a 5.0% Days in inventory, net 40.0 40.0
Operating costs 80.0% 80.0%
Days in property and equipment
200.0 200.0
Depreciation 5.0% 5.0%
Operating profits 15.0% 15.0%
Cost of debt 8.0% 8.0%
Taxes 25.0% 25.0%