Question 1: Corporate Valuation You Have Been Hired As A Con

Question 1: Corporate Valuationyou Have Been Hired As A Consultant To

You have been hired as a consultant to Advanced Fuels Corporation, to find a way to increase its value to the shareholders. The CEO has asked you to determine the value of a privately held company that Advanced Fuels is considering to acquire. You need to define and determine the following items: (a) what are assets in place, and how can their value be determined? (b) what are nonoperating assets, and how can their value be determined? (c) what is the total value of a corporation, and who has claims on this value? (d) The privately held company is owned by a family, with 10 million shares of stock. Its Free Cash Flow (FCF) is $20 million, WACC is 12%, and FCF is expected to grow at a constant annual rate of 7%. The company holds marketable securities worth $90 million. It is financed with $200 million in debt and has $250 million in book common equity. You are asked to calculate: 1) the value of operations, 2) the total corporate value, 3) the intrinsic value of equity, 4) the intrinsic stock price per share, and 5) a fair offer price per share. (e) Finally, list the six potential managerial behaviors that can harm a firm’s value.

Paper For Above instruction

Corporate valuation is a fundamental aspect of financial management and investment decision-making. It involves assessing the intrinsic worth of a company's assets and earnings prospects to determine its current and potential future value, which guides shareholders, potential investors, and managers in making informed decisions. This paper explores key components of company valuation including assets in place, non-operating assets, and overall corporate value, along with practical calculations and managerial considerations that influence firm value.

Assets in Place and Their Valuation

Assets in place refer to the tangible and intangible assets that a company currently owns and utilizes in its ongoing operations. These include physical assets like property, plant, equipment, inventory, and cash, as well as intangible assets such as patents, trademarks, and customer relationships. The valuation of assets in place primarily depends on their expected future cash flows, which can be discounted to present value using cost of capital or other valuation techniques. Techniques such as the Asset-Based Approach and discounted cash flow (DCF) analysis are commonly employed. For example, in a DCF approach, projected cash flows attributable to these assets are discounted at an appropriate discount rate to estimate their current worth.

Non-operating Assets and Their Valuation

Non-operating assets are assets not essential for the core business operations. These may include excess cash, marketable securities, real estate holdings unrelated to operations, or investments that are not involved in generating the company's primary revenue. Their valuation involves estimating the fair market value of these assets independently from the firm's operational assets. Market value approaches are typically used, utilizing recent market prices or appraisals for securities and properties. For instance, marketable securities valued at $90 million can be appraised based on current market quotations to determine their worth separately from the operational valuation.

The Total Value of a Corporation and Claimants

The total value of a corporation, often termed enterprise value (EV), comprises the cumulative value of its operational assets and non-operating assets and reflects the market’s estimate of the company’s overall worth. Claims on this value are held by various parties: debt holders have claims equivalent to the company's debt obligations; equity holders (shareholders) have residual claims after debt obligations are satisfied. The enterprise value minus net debt (total debt minus cash and equivalents) equates to the equity value, representing the shareholders' claim on the firm's assets.

Calculations and Valuation of the Target Company

Given the data: Free Cash Flow (FCF) of $20 million, WACC of 12%, and growth rate of 7%, we proceed to determine the value of operations. Using the enterprise valuation model for a continuous growth scenario:

Value of Operations (V_O) = FCF₁ / (WACC - g) = (FCF₀ * (1 + g)) / (WACC - g)

Where FCF₀ = $20 million, g = 7%, WACC=12%. Plugging in the numbers:

V_O = ($20 million * 1.07) / (0.12 - 0.07) = $21.4 million / 0.05 = $428 million.

Next, the total corporate value includes the holdings of marketable securities valued at $90 million, so total value becomes:

Total Corporate Value = Value of operations + Marketable securities = $428 million + $90 million = $518 million.

To determine the intrinsic value of equity, we subtract net debt from the total corporate value. Net debt is calculated as total debt ($200 million) minus cash equivalents. Since cash equivalents are not explicitly provided, assuming the holdings in marketable securities of $90 million are primarily cash equivalents, net debt can be considered as $200 million - $90 million = $110 million. Therefore, the equity value is:

Equity Value = Total Corporate Value - Net Debt = $518 million - $110 million = $408 million.

With 10 million shares outstanding, the intrinsic stock price per share is:

Stock Price = Equity Value / Number of Shares = $408 million / 10 million = $40.80 per share.

A fair offer price per share should consider premium for acquisition, market conditions, and strategic value; typically, a 10-20% premium over intrinsic value is considered fair, suggesting an offer price of approximately:

Fair offer price per share ≈ $40.80 * 1.15 ≈ $46.92.

Six managerial behaviors that can harm a firm's value include:

1. Overestimating growth prospects to inflate valuation.
2. Engaging in empire-building that misallocates resources.
3. Failing to manage earnings and financial reporting transparently.
4. Ignoring stakeholder interests or neglecting corporate governance standards.
5. Engaging in excessive risk-taking or leveraging without adequate safeguards.
6. Misalignment of managerial incentives leading to short-termism.

In conclusion, the valuation process involves analyzing operational and non-operational assets, understanding claims held by different stakeholders, and considering managerial behaviors that could undermine company value. Applying these principles enables informed corporate decisions, such as acquisitions or strategic growth plans, ultimately enhancing shareholder value.

References

• Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (3rd ed.). Wiley.
• penman, S. H. (2010). Financial Statement Analysis and Security Valuation. McGraw-Hill/Irwin.
• Nees, C., & Walther, B. (2013). Corporate Valuation and Strategies. Springer.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
• Fernandez, P. (2018). Valuation Techniques. European Financial Management, 24(4), 721-743.
• Graham, J. R., & Harvey, C. R. (2001). The Theory and Practice of Corporate Finance: Evidence from the Field. Journal of Financial Economics, 60(2-3), 187-243.
• Wei, K., & Guo, L. (2018). Firm valuation and corporate governance. Review of Accounting Studies, 23(4), 1281-1318.
• McKinsey & Company. (2016). Valuation: Measuring and Managing the Value of Companies. 6th ed. Wiley.
• Damodaran, A. (2017). Narrative and numbers: The value of storytelling in investment. Journal of Applied Corporate Finance, 29(2), 111-113.