Rjr Nabisco Essay

1026 Words Sep 28th, 2008 5 Pages
RJR Nabisco
Case Study

1. The RJR Nabisco Company passed trough some amazing facts of its financial life in the years of operating, starting as a tobacco company in 1875. In order to analyze RJR Nabisco company as a potentially candidate for leverage buyout (LBO) it is important to understand that all firms may be the targets of a leveraged buyout, but because of the importance of debt and the ability of the acquired firm to make regular loan payments after the completion of a leveraged buyout. Some features of potential target firms make for more attractive leverage buyout candidates. For one company to be said that is good candidate for LOB needs to include the following: low existing debt loads, a multi-year history of
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In theory, if all information is provided, all three methods lead to the same value. As a guide line, one should use WACC or FTE if the firm’s target debt-to-value ratio applies to the project over its life time, and one should use APV if the project’s level of debt is known over the life of the project. In Exhibits 5, 6 and 7, it is given information about the level of debt during the time of the project, and debt-to-value ratio is not constant. The optimal decision was to use APV approach.
The first step was to calculate R0. As the asset beta is not given, we used CAPM to calculate the equity cost of capital. To calculate the equity beta, we used an arithmetic average of the historical betas (from 1982 to 1987). Because beta is a very volatile quantity, the beta of 1987 may not fully represent the real equity beta of RJR Nabisco. We obtained βS=0.89. The risk-free rate and the market premium are assumed to be 9% and 8%, respectively, so we obtained an equity cost of capital of (RS) of 16.15%. To obtain R0, we solved the equation in MM II Proposition: Note that we want to calculate the value of RJR Nabisco for the year of 1987, so we used exhibit 3 to get the debt-equity ratio in 1987 and exhibit 2 to calculate the value of taxes paid in the same year. We assume that Net income is operational Income minus Interest and minus taxes, which leads to the following formula:
T=1-Net

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