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FINANCE SIMULATION WORKSHEET INSTRUCTIONS

Part 2 – Enterprise Valuation

CEOs: Now that you have completed your strategic and financial assessment of the firms in the wine industry, it is time to determine what the potential target firms are worth so you may pursue a deal.

Review the valuation models on the simulation website as well as the foreground reading and company financials posted on Blackboard in the ‘Simulation’ section. Your assignment is to produce two deliverables which are detailed in the sections that follow:

Conduct an Enterprise Valuation of Bel Vino and Starshine using the Excel template provided on Blackboard.

Write a letter to the chairman of the board summarizing your analysis and bidding strategy for your chosen target.

All portions of this assignment must be typed. You must turn in both the summary letter and the enterprise valuation analysis Excel worksheet electronically through Blackboard and physically in hard-copy format (double-sided is preferred) to my mailbox in the finance department. The letter to the chairman should be placed up front with the valuation analysis and supporting exhibits behind it.

The project worksheet should be completed on an individual basis, but you may utilize the professor or the online help forums on Blackboard to help you through the assignment. Emailed or late projects will not be accepted.

Instructions for Completing the Enterprise Valuation Analysis

To complete the enterprise valuation analysis, use the confidential information, foreground reading and the financial data for Bel Vino, Starshine, and International Beverage posted on Blackboard and the simulation website to fill out the Excel template provided. You should not modify the format of this template.

The goal of this valuation exercise is to derive reservation prices for Bel Vino and Starshine. Note: Deriving an accurate reservation price for each firm is ESSENTIAL to your success in the online portion of the game and your score on the overall project. Before settling on a valuation, make sure you have analyzed the assumptions underlying each methodology for their validity. Many of the valuation techniques studied here will not be appropriate for the final reservation price. Think critically!

You should use the calculations performed on the simulation website to complete this analysis. Where asked, you should enter in the entirety of your confidential information into the ‘Changes in Operating Assumptions’ section. For those values given as a range, you may enter the midpoint of that range.

Instructions for WACC-based Discounted Cash Flows (WACC-DCF) Valuation

Examine the ‘WACC-based DCF’ and ‘Discount Rates + TV’ tabs. Compute the projected cash flow from assets for Bel Vino and Starshine using your confidential information and determine the WACC-based DCF value of each firm.

You should review the chapters titled “Stock Valuation” and “Valuation and Capital Budgeting for the Levered Firm” in the course text to assist you with this section.

The WACC-DCF method attempts to value the firm’s levered assets by discounting the unlevered free cash flows (CFAs) at a levered weighted average cost of capital. Conceptually, this technique is most similar to the NPV method.

Using a forecasting horizon of 5 years (2013-2017), the value of the levered enterprise (MVA) is determined by:

MVALevered,2012 = FCF2013/(1+RWACC)1+FCF2014/(1+ RWACC)2+…+FCF2017/(1+ RWACC)T

+TV2017/(1+ RWACC)T

where TV is often valued as a growing perpetuity TV2017 = FCF2018 / (RWACC – g) and all cash flows are discounted at the weighted average cost of capital. When estimating the WACC to discount the projected cash flows, you should use the WACC calculated by the simulation. Alternatively, the terminal value is estimated as a market multiple.

As part of this exercise, you will have to choose a method for the terminal value (i.e. the horizon value) of the enterprise. Your choices are to use: 1) Growing Perpetuity (TV2017=CFA2018/(rWACC-g)), 2) Sales Multiple (some multiple of 2017 sales), or 3) Earnings Multiple (some multiple of 2017 EBITDA). Carefully study the assumptions underlying each choice when formulating your reservation price! The model is very sensitive to this input.

Once you determine the market value of the firm’s assets (MVA2012), you can subtract the value of the debt to get the market value of the equity (MVE2012). Dividing by the number of shares arrives at the intrinsic price per share (P2012).

Instructions for Adjusted Present Value (APV) Valuation

Examine the ‘Adjusted Present Value’ and ‘Discount Rates + TV’ tabs. Compute the projected cash flow from assets for Bel Vino and Starshine using your confidential information and determine the adjusted present value of each firm.

You should review the chapters titled “Stock Valuation” and “Valuation and Capital Budgeting for the Levered Firm” in the course text to assist you with this section.

The adjusted present value method aims to discount the unlevered free cash flows at the unlevered cost of capital (not WACC) and then adjust this amount by the value of the financing effects associated with debt. Conceptually, this method follows from proposition I of the M&M theory which states that:

MVALevered = MVAUnlevered + Financing Effects.

Specifically, we discount the unlevered free cash flows (CFA) plus the value of the financing effects (i.e., interest tax shields), the market value of the levered enterprise is:

MVALevered,2012 = (CFA2013+Fin2013)/(1+RA)1 + (CFA2014+Fin2014)/(1+ RA)2 + …

+ (CFA2017+Fin2017)/(1+ RA)T + (TVCFA,2017+TVFin,2017)/(1+ RA)T

The terminal value, TV, in this case is the value of both the unlevered cash flows (i.e., CFA) and the financing effects (i.e., interest tax shield) in perpetuity as of time = 2017.

Since we explicitly account for the tax deductibility of interest in the cash flows themselves, everything is discounted at the unlevered asset cost of capital. This is defined by the CAPM as RA = Rf + βA * RPM = Rf + βA * (R​M – Rf).

Once you determine the market value of the firm’s assets (MVA2012), you can subtract the value of the debt to get the market value of the equity (MVE2012). Dividing by the number of shares arrives at the intrinsic price per share (P2012).

Instructions for Market Multiples, Prior Transactions, and Book Value of Equity

Compute the equity value per share (MVE / # shares) of Bel Vino and Starshine using your confidential information and market multiples of their peer firms and the transaction prices of past acquisitions (see ‘Comparable Companies’ and ‘Comparable Transactions’). Compute the book value per share using the book value of equity for each firm.

For more information, consult the chapter titled “Stock Valuation,” p. 547-551 from the course text. REMEMBER: Some market multiples are used to value the entire enterprise (i.e. MVA) and some value only the equity (i.e. MVE). You must subtract the value of debt from MVA to get MVE.

Instructions for Formulating a Reservation Price

Determine the reservation prices for Bel Vino and Starshine using your confidential information (these values should be based off of your adjustments to the online model). The reservation price represents what you think each firm is truly worth. You should NOT bias your reservation price in any way.

When coming up with your reservation price, you should only use the valuation estimates in Sections 2-4 & 6 that you think are accurate. You should keep in mind the assumptions of each technique when formulating a single reservation price. That is, if you think that the market multiples or the comparable transactions methods are not perfect matches, you should rely on only the intrinsic valuation methodologies (i.e. WACC-DCF and APV).

Deriving accurate reservation prices is CRITICAL to your success in the online portion of the game. Once your reservation price is set, it cannot be changed.

Instructions for the Starting Bids

You should formulate a starting bid on the basis of your reservation prices and your overall bidding strategy. Your reservation prices have an interpretation in the bidding phase of the simulation. The Bel Vino reservation price represents the minimum bid that you should accept if you are Bel Vino or the most that you would be willing to pay for Bel Vino if you are Starshine or International Beverage. The Starshine reservation price represents the minimum bid that you should accept if you are Starshine or the most that you would be willing to pay for Starshine if you are Bel Vino or International Beverage.

(BV and SS Players) What is the per share value of your intended opening bid for your opponent (place ‘NA’ in the cell for your own firm)? (IB Players) Present your work as if you intended to acquire both targets. What would be the per share value of your opening bid for each?

Note: It is recommended that you consult the ‘Scoring Scheme’ of the ‘Finance Simulation Description’ document on Blackboard prior to second round play so you are aware of how the online portion is scored.

Instructions for Accretion / Dilution (BV and SS Players only)

Use the ‘share exchange calculator’ under the decide tab to determine how many shares you should offer to your opponent using your starting bid value from above. All of your bids will be in the form of a share exchange ratio, not a dollar amount offer. Use the ‘accretion / dilution calculator’ under the decide tab to determine how a proposed share exchange at your starting bid value will affect next year’s earnings per share. For more information, consult the Mergers and Acquisitions chapter of your course text for the ‘NPV of a Merger’ using common stock and ‘Two Financial Side Effects of Acquisitions’ with respect to earnings growth.

Instructions for the Leverage Decision (IB Players only)

International Beverage’s debtholders have placed the covenants (constraints) below upon IB’s management for any offer made.

Covenant	Value
TIE Ratio (EBIT/ Interest)	2.50
Debt to Value Ratio	85%
Total Debt	$700,000,000

Use the ‘leverage decision calculator’ under the decide tab to determine how IB’s management will finance an acquisition for either Bel Vino or Starshine. The leverage decision calculator will show you how much value is created from the structure (i.e. cash v. debt) of your bid. It is independent of the value creation or destruction from choosing the correct bid price. Complete both analyses for a hypothetical acquisition of each company at your starting bid values detailed above.