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Note that there is a difference between UFCF defined above and what are referred to as “free cash flows” in Exhibit 13 (on line 14)? • Discount Rates. As we mentioned when discussing the Marriott case, the choice of discount rates is an important part of any valuation procedure. It is worthwhile to spend some time thinking carefully about these issues. – Congoleum’s equity beta is known (see Exhibit 9). Do you need to rely on comparable companies’ data to obtain Congoleum’s asset beta? – For the borrowing cost in the LBO years and the borrowing cost in the post-1984 period, you may use an average of the yields on corporate bonds of appropriate ratings (Exhibit 10). In particular, in this case, it would probably not be legitimate to use the coupon rates on the new LBO debts as rD in the LBO years. Why? Of course, this means that the loans have a positive net present value (the coupon rate is less than the discount rate), so don’t forget that part of the value. For the post-1984 period, should we expect the bond rating to improve (and rD to decrease)? Why or why not? – For the
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You should also explore a few additional debt-to-value ratios around this number in your sensitivity analysis. – Feel free to use the information in the footnote to Exhibit 9 as your inputs (risk-free rate and market premium) to the CAPM. – Feel free to do all your levering/unlevering assuming a debt beta of zero. Also, let us assume that all debt is permanent (i.e., not rebalanced). – Wherever the case mentions “Debt % capital”, you can treat this as the correct (i.e., market) debt-to-value ratio. • Adjusted Present Value (APV). The present value of financing decisions is obtained by discounting all relevant debt cash flows at Congoleum’s debt cost: principal receipts, principal repayments, interest payments, interest tax shields. Indeed, as mentioned above, it is not sufficient to just include the tax shields in your valuation, as the coupon rate on the debt is smaller than the proper (i.e., market) discount rate; that is, the loan has a positive net present value. Also note the following. – Preferred stock can be thought of as a type of debt that does not create any interest tax shields. – Do not forget that some “old” long-term debt remains after 1979 and the new owners need to service it even though no cash is received on this debt in 1979. – It is convenient, for valuation purposes, to assume that all debts (old, new, preferred stock) are paid off at the end of 1984 when the LBO group takes the company public again and sells it for its terminal value.1 • Terminal Value. Obtaining an accurate measure of the terminal value is critical in this case. You may start with the following as an approximation: Terminal Value as of 1984 = (1 + g) × (Avg UFCF)1980-1984 , (Discount Rate)post 1984 −
You should also explore a few additional debt-to-value ratios around this number in your sensitivity analysis. – Feel free to use the information in the footnote to Exhibit 9 as your inputs (risk-free rate and market premium) to the CAPM. – Feel free to do all your levering/unlevering assuming a debt beta of zero. Also, let us assume that all debt is permanent (i.e., not rebalanced). – Wherever the case mentions “Debt % capital”, you can treat this as the correct (i.e., market) debt-to-value ratio. • Adjusted Present Value (APV). The present value of financing decisions is obtained by discounting all relevant debt cash flows at Congoleum’s debt cost: principal receipts, principal repayments, interest payments, interest tax shields. Indeed, as mentioned above, it is not sufficient to just include the tax shields in your valuation, as the coupon rate on the debt is smaller than the proper (i.e., market) discount rate; that is, the loan has a positive net present value. Also note the following. – Preferred stock can be thought of as a type of debt that does not create any interest tax shields. – Do not forget that some “old” long-term debt remains after 1979 and the new owners need to service it even though no cash is received on this debt in 1979. – It is convenient, for valuation purposes, to assume that all debts (old, new, preferred stock) are paid off at the end of 1984 when the LBO group takes the company public again and sells it for its terminal value.1 • Terminal Value. Obtaining an accurate measure of the terminal value is critical in this case. You may start with the following as an approximation: Terminal Value as of 1984 = (1 + g) × (Avg UFCF)1980-1984 , (Discount Rate)post 1984 −