Valuation

Measuring and Managing the Value of Companies

5th Edition

Chapter 10 Solutions
Estimating Continuing Value
Version 1.0
April 1, 2010

Chapter 10
Question 1

Today
250.0
(225.0)
25.0

Year 1
265.0
(238.5)
26.5

Year 2
280.9
(252.8)
28.1

Year 3
297.8
(268.0)
29.8

Year 4
315.6
(284.1)
31.6

Year 5
334.6
(301.1)
33.5

Continuing
value
354.6
(319.2)
35.5

Operating taxes
NOPLAT

(6.6)
19.9

(7.0)
21.1

(7.4)
22.3

(7.9)
23.7

(8.4)
25.1

(8.9)
26.6

Net investment
Free cash flow

(8.0)
11.9

(8.4)
12.6

(8.9)
13.4

(9.5)
14.2

(10.0)
15.1

CV
399.0

Discounted cash flow

Discount rate
Discounted cash flow

1.21
10.4

1.33
10.1

1.46
9.7

1.61
9.3

1.61
247.7

Revenues
Operating costs
Operating margin

1.10
10.8

Value of operations

Discounted cash flow

Present value of CV
Value of operations

$ million
50.4
247.7
298.1

Percent
of total
16.9%
83.1%
100.0%

Continuing value
NOPLAT
Growth
Return on new capital
Cost of capital
Key value driver formula

26.6
6.0%
15.0%
10.0%
399.0

p
Question 2

Today
250.0
(225.0)
25.0

Year 1
265.0
(238.5)
26.5

Year 2
280.9
(252.8)
28.1

Continuing
value
297.8
(268.0)
29.8

Operating taxes
NOPLAT

(6.6)
19.9

(7.0)
21.1

(7.4)
22.3

Net investment
Free cash flow

(8.0)
11.9

(8.4)
12.6

CV
335.0

Discounted cash flow

Discount rate
Discounted cash flow

1.10
10.8

1.21
10.4

1.21
276.8

Revenues
Operating costs
Operating margin

Value of operations

Discounted cash flow

Present value of CV
Value of operations

$ million
21.3
276.8
298.1

Percent
of total
7.1%
92.9%
100.0%

Continuing value
NOPLAT
Growth
Return on new capital
Cost of capital
Key value driver formula

22.3
6.0%
15.0%
10.0%
335.0

Chapter 10
Question 3

Revenues
Operating costs
Operating margin
Operating taxes
NOPLAT

Today
250.0
(225.0)
25.0

Year 1
265.0
(238.5)
26.5

Year 2
280.9
(252.8)
28.1

Year 3
297.8
(268.0)
29.8

Year 4
315.6
(284.1)
31.6

Year 5
334.6
(301.1)
33.5

Continuing
value
354.6
(319.2)
35.5

(6.3)
18.8

(6.6)
19.9

(7.0)
21.1

(7.4)
22.3

(7.9)
23.7

(8.4)
25.1

(8.9)
26.6

Invested capitalt1

132.5

140.5

148.9

157.8

167.3

177.3

Cost of capital
Capital charge

10.0%
13.3

10.0%
14.0

10.0%
14.9

10.0%
15.8

10.0%
16.7

10.0%
17.7

Economic profit

Discounted economic profit

Economic profit
Discount rate
Discounted economic profit

6.6

6.6
1.10
6.0

Value of operations

Invested capital
PV (economic profit)
PV (continuing value)
Value of operations

$ million
132.5
28.0
137.6
298.1

Percent
of total
44.4%
9.4%
46.2%
100.0%

7.0

7.0
1.21
5.8

7.4

7.4
1.33
5.6

7.9

7.9
1.46
5.4

8.4

8.4
1.61
5.2

8.9

CV
221.6
1.61
137.6

Continuing value
Economic profit
Cost of capital
Economic profit in year 1

8.9
10.0%
88.7

NOPLAT
Growth
RONIC
WACC

26.6
6.0%
15.0%
10.0%

Economic profit beyond year 1

Continuing value

133.0
221.6

Chapter 10
Question 4

Revenues
Operating costs
Operating margin
Operating taxes
NOPLAT

Today
250.0
(225.0)
25.0

Year 1
265.0
(238.5)
26.5

Year 2
280.9
(252.8)
28.1

Continuing
value
297.8
(268.0)
29.8

(6.3)
18.8

(6.6)
19.9

(7.0)
21.1

(7.4)
22.3

Invested capitalt1

132.5

140.5

148.9

Cost of capital
Capital charge

10.0%
13.3

10.0%
14.0

10.0%
14.9

Economic profit

Continuing value
Economic profit
Cost of capital
Economic profit in year 1

7.4
10.0%
74.4

NOPLAT
Growth
RONIC
WACC

22.3
6.0%
15.0%
10.0%

Economic profit beyond year 1

Continuing value

Discounted economic profit

Economic profit
Discount rate
Discounted economic profit

6.6

6.6
1.10
6.0

Value of operations

Invested capital
PV (economic profit)
PV (continuing value)
Value of operations

$ million
132.5
11.8
153.8
298.1

Percent
of total
44.4%
4.0%
51.6%
100.0%

7.0

7.0
1.21
5.8

7.4

CV
186.1
1.21
153.8

111.7
186.1

Chapter 10
Question 5 & 6
Question 5
Perpetuity formulas cannot be used when growth exceeds the cost of capital. When this occurs, cash flows grow
faster than they can be discounted, and consequently value is infinite. From an economic perspective, growth
must eventually fall as the company grows larger (a $250 billion company cannot continually grow faster than
10 percent). To avoid this problem, extend the forecast period until growth stabilizes at a real growth rate
no higher than 5 percent.

Question 6
As Exhibit 10.6 demonstrates, return on total capital does not necessarily equal return on new capital. Return
on total capital is a blend between return on existing capital (i.e., capital that existed at the start of the continuing
value period) and return on new invested capital. As the company adds new capital, return on total capital will
trend toward return on new invested capital. Therefore, SuperiorCo will have return on total capital above
the cost of capital, even during the continuing value period.

EXHIBIT 10.13 ApparelCo:

Free Cash Flow and Economic Profit Forecasts

$ million

Revenues
Operating costs
Operating profit

Today
250.0
(225.0)
25.0

Year 1
265.0
(238.5)
26.5

Year 2
280.9
(252.8)
28.1

Year 3
297.8
(268.0)
29.8

Year 4
315.6
(284.1)
31.6

Year 5
334.6
(301.1)
33.5

Continuing
value
354.6
(319.2)
35.5

Operating taxes
NOPLAT

(6.3)
18.8

(6.6)
19.9

(7.0)
21.1

(7.4)
22.3

(7.9)
23.7

(8.4)
25.1

(8.9)
26.6

Net investment
Free cash flow

(8.0)
11.9

(8.4)
12.6

(8.9)
13.4

(9.5)
14.2

(10.0)
15.1

Economic profit
NOPLAT

19.9

21.1

22.3

23.7

25.1

26.6

Invested capitalt1

132.5

140.5

148.9

157.8

167.3

177.3

Cost of capital (percent)

Capital charge

10.0
13.3

10.0
14.0

10.0
14.9

10.0
15.8

10.0
16.7

10.0
17.7

Economic profit

6.6

7.1

7.4

7.9

8.4

8.9

Chapter 10
Question 1

Revenues
Operating costs
Operating margin
Operating taxes
NOPLAT

Today
250.0

Year 1
265.0

Year 2
280.9

Year 3
297.8

Year 4
315.6

Year 5
334.6

Continuing
value
354.6

(225.0)
25.0

(238.5)
26.5

(252.8)
28.1

(268.0)
29.8

(284.1)
31.6

(301.1)
33.5

(319.2)
35.5

(6.3)
18.8

(6.6)
19.9

(7.0)
21.1

(7.4)
22.3

(7.9)
23.7

(8.4)
25.1

(8.9)
26.6

Net investment

(8.0)

(8.4)

(8.9)

(9.5)

(10.0)

Free cash flow

11.9

12.6

13.4

14.2

15.1

399.0

Discounted cash flow

Discount rate
Discounted cash flow

1.10
10.8

1.21
10.4

1.33
10.1

1.46
9.7

1.61
9.3

1.61
247.7

132.5
2.00

140.5
2.00

148.9
2.00

Value of operations

Check
Invested capitalt1
Invested capital turnover

CV

0.0

157.8
2.00

167.3
2.00

177.3
2.00

Key value drivers

Investment rate
Return on new capital
Growth rate

40.0%

40.0%

15.0%
6.0%

15.0%
6.0%

Operating margin
Operating taxes
NOPLAT margin

10.0%
25.0%
7.5%

10.0%
25.0%
7.5%

Capital turnover
Return on invested capital

2.0
15.0%

2.0
15.0%

Cost of capital

10.0%

10.0%