|


  

Calculating the NPV of the acquisition

 


anufactures food products (Oreo cookies), cigarettes, etc.

Poor share price performance ( stagnant at $55)

Outstanding debt valued at $5 billion

 



V V was boosting sales by loading cigarette inventories

on its distributors.

Dealers were encouraged to purchased billions in

surplus cigarettes just before semi-annual price
increase were put in effect
 


ome analysts estimated that there were 18 billion
excess cigarettes on dealers' shelves as of anuary 1,
1989.

As a result, V V was able to report higher sales and

earnings.

In doing so, the management:

- forfeited future sales at higher prices
- accelerated the payment of excise taxes
- turned off smokers
 |
 





|he company was trying to produce a smokeless

cigarette to boost the market value of V V shares.

At least, it was believed so.

 |
 





|he smokeless cigarette, however, had a very unpleasant

taste.
 ]
 
 


|hey planned to issue almost $24 billion in new debt,

buy V V, and sell several V V food divisions.
 @
 
!


 

  "#$
%

|he forecasting horizon was divided in two subperiods: pre and post 1993

Unlevered cash flow and tax shields were elaborately forecasted up to

1993

Unlevered cash flow was projected to grow at a constant rate after 1993

|he tax shield after 1993 was estimated using 
 1963
 @  $ !&

  

1989 1990 1991 1992 1993

Operating income 2,620 3,410 3,645 3,950 4,310
|ax on operating income 891 1,142 1,222 1,326 1,448
After tax operating income 1,729 2,268 2,423 2,624 2,862
Add back depreciation 449 475 475 475 475
Less capital expenditures 522 512 525 538 551
Less change in WC -203 -275 200 225 250
Proceeds from assets 3,545 1,805 - - -
sales
Unlevered cash flow 5,404 4,311 2,173 2,336 2,536
 @  $ !&

  

1989 1990 1991 1992 1993

Operating income 2,620 3,410 3,645 3,950 4,310
|ax on operating income 891 1,142 1,222 1,326 1,448
After tax operating income 1,729 2,268 2,423 2,624 2,862
Add back depreciation 449 475 475 475 475
Less capital expenditures 522 512 525 538 551
Less change in WC -203 -275 200 225 250
Proceeds from assets 3,545 1,805 - - -
sales
Unlevered cash flow 5,404 4,311 2,173 2,336 2,536
 @  $ !&

  

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 @  $ !&

  

1989 1990 1991 1992 1993

Operating income 2,620 3,410 3,645 3,950 4,310
|ax on operating income 891 1,142 1,222 1,326 1,448
After tax operating income 1,729 2,268 2,423 2,624 2,862
Add back depreciation 449 475 475 475 475
Less capital expenditures 522 512 525 538 551
Less change in WC -203 -275 200 225 250
Proceeds from assets 3,545 1,805 - - -
sales
Unlevered cash flow 5,404 4,311 2,173 2,336 2,536
 @  $ !&

  

r ti ic  , 

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,
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 r ti ic   , , ,
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 @  $ !&

  

1989 1990 1991 1992 1993

Operating income 2,620 3,410 3,645 3,950 4,310
|ax on operating income 891 1,142 1,222 1,326 1,448
After tax operating income 1,729 2,268 2,423 2,624 2,862
Add back depreciation 449 475 475 475 475
Less capital expenditures 522 512 525 538 551
Less change in WC -203 -275 200 225 250
Proceeds from assets 3,545 1,805 - - -
sales
Unlevered cash flow 5,404 4,311 2,173 2,336 2,536
 @  $ !&

  

1989 1990 1991 1992 1993

Operating income 2,620 3,410 3,645 3,950 4,310
|ax on operating income 891 1,142 1,222 1,326 1,448
After tax operating income 1,729 2,268 2,423 2,624 2,862
Add back depreciation 449 475 475 475 475
Less capital expenditures 522 512 525 538 551
Less change in WC -203 -275 200 225 250
Assets sales 3,545 1,805 - - -
Unlevered cash flow 5,404 4,311 2,173 2,336 2,536
 @  $ !&

  

     

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,
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 r ti ic   , , ,
 ,
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 —&





'!

 

1989 1990 1991 1992 1993

Interest expense 3,384 3,004 3,111 3,294 3,483
|ax shield (| =34%) 1,151 1,021 1,058 1,120 1,184
 —&





'!

 

1989 1990 1991 1992 1993

Interest expense 3,384 3,004 3,111 3,294 3,483
|ax shield (| =34%) 1,151 1,021 1,058 1,120 1,184
 |
!


  



  $

PVUCF (µ89-¶93) at 14% = $12,224 m

PVUCF (>µ93) = 2,536(1.03)/[(0.14 - 0.03)(1.14)5] = $ 12,330m

(g = 3%)
|
!


 
' 
 !(

Cost of debt = 13.5%

PV| (µ89 - µ93) = $3,877 m

 |
!


 
' 

(

|ax shield (1993) = VL(1993) - VU(1993)

D/E = 1/3
WACC (1993)= 12.8%
r(cost of equity) = 14%
g = 3%

VL(1993) = UCF(1994)/(wacc -g)= $2,536(1.03)/(0.128-0.03) = $26,653.9 m

VU(1993) = UCF(1994)/(r -g) = $2,536(1.03)/[(0.14 - 0.03) = $23,746 m

|ax shield (1993) = $26,653.9 - $ 23,746 m = $2,908 m

PV| (>1993) = $1,544 m
 |

 "

PVUCF(µ89-¶93) +PVUCF(>µ93) + PV|(µ89 -µ93) + PV| (>¶93)

$12,224 m + $12,333 m+ $3,877 m + $1,544 m = )*+

|


 
, 

VL - D = E

$29,978 m - $5,000 m = $24,978 m

P = $109.07 per share