Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A-1
The Adjusted Prent Value Approach to Valuing Leveraged Buyouts 1
Introduction
A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company fi nanced primarily with debt. The equityholders rvice the heavy inter-est and principal payments with cash from operations and/or ast sales. The shareholders generally hope to rever the LBO within three to ven years by way of a public offering or sale of the company to another fi rm. A buyout is therefore likely to be successful only if the fi rm generates enough cash to rve the debt in the early years, and if the company is attractive to other buyers as the buyout matures.
In a leveraged buyout, the equity investors are expected to pay off outstanding principal according to a specifi c timetable. The owners know that the fi rm’s debt–equity ratio will fall and can forecast the dollar amount of debt needed to fi nance future operations. Under the circumstances, the adjusted prent value (APV) approach is more practical than the weighted average cost of capital (WACC) approach becau the capital structure is chang-ing. In this appendix, we illustrate the u of this procedure in valuing the RJR Nabisco transaction, the largest LBO in history.
The RJR Nabisco Buyout In the summer of 1988, the price of RJR stock was hovering around $55 a share. The fi rm had $5 billion of debt. The fi rm’s CEO, acting in concert with some other nior managers of the fi rm, announced a bid of $75 per share to take the fi rm private in a management buyout. Within days of management’s offer, Kohlberg, Kravis, and Roberts (KKR) entered the fray with a $90 bid of their own. By the end of November, KKR emerged from the ensuing bidding process with an offer of $109 a share, or $25 billion total. We now u the APV technique to analyze KKR’s winning strategy.
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The APV method as described in this chapter can be ud to value companies as well as projects. Applied in this way, the maximum value of a levered fi rm (V L ) is its value as an all-equity entity (V U ) plus the discounted value of the interest tax shields from the debt its asts will support (PVTS).2 This relation can be stated as: V L ϭ V U ϩ PVTS
ϭ t =∞
∑
国庆节国旗下讲话1 UCF t ________ (1 ϩ R 0)t
ϩ t =∞
∑1
t C R B B t Ϫ 1
_________(1 ϩ R B )t
In the cond part of this equation, UCF t is the unlevered cash fl ow from operations for year t. Discounting the cash fl ows by the required return on asts, R 0, yields the all-
万圣节快乐英文e quity value o
f the company. B t Ϫ1 reprents the debt balance remainin
g at the end of year (t Ϫ 1). Becau interest in a given year is bad on the debt balance remaining at the end of the previous year, the interest paid in year t is R B B t Ϫ1. The numerator of the cond term,
Appendix 17A
1
This appendix has been adapted by Isik Inlbag and Howard Kaufold, The Wharton School, University of Pennsylvania, from their unpublished manuscript titled “Analyzing the RJR Nabisco Buyout: An Adjusted Pres-ent Value Approach.”2
We should also deduct from this value any costs of fi nancial distress. However, we would expect the costs to be small in the ca of RJR for two reasons. As a fi rm in the tobacco and food industries, its cash fl ows are relatively stable and recession resistant. Furthermore, the fi rm’s asts are divisible and attractive to a number of potential buyers, allowing the fi rm to receive full value if disposition is required.
17A-2 Part IV Capital Structure and Dividend Policy
t C R B B t Ϫ1, is therefore the tax shield for year t. We discount this ries of annual tax shields using the rate at which the fi rm borrows, R B .3
KKR planned to ll veral of RJR’s food divisions and operate the remaining parts of the fi rm more effi ciently. Table 17A.1 prents KKR’s projected unlevered cash fl ows for RJR under the buyout, adjusting for planned ast sales and operational effi ciencies. With respect to fi nancial strategy, KKR planned a signifi cant increa in leverage with accompanying tax benefi ts. Specifi ca
lly, KKR issued almost $24 billion of new debt to complete the buyout, raising annual interest costs to more than $3 billion.4 Table 17A.2 prents the projected interest expen and tax shields for the transaction.
We now u the data from Tables 17A.1 and 17A.2 to calculate the APV of the RJR buyout. This valuation process is prented in Table 17A.3.The valuation prented in Table 17A.3 involves four steps.St ep 1: Calculating the prent value of unlevered cash fl ows for 1989–1993 The u nlevered cash fl ows for 1989–1993 are shown in the last line of Table 17A.1 and the fi rst line of Table 17A.3. The fl ows are discounted by the required ast return, R 0, which at the time of the buyout was approximately 14 percent. The value as of the end of 1988 of the u nlevered cash fl ows expected from 1989 through 1993 is:
5.404 _____1.14 ϩ 4.311 _____1.142 ϩ 2.173 _____1.143 ϩ 2.336 _____1.14
4 ϩ 2.536 _____1.14
5 ϭ $12.224 billion Step 2: Calculating the prent value of the unlevered cash fl ows beyond 1993 (unlevered terminal value) We assume the unlevered cash fl ows grow at the modest annual rate of
3
The pretax borrowing rate, R B , reprents the appropriate discount rate for the interest tax shields when there is a precommitment to a specifi c debt repayment schedule under the terms of the LBO. If debt covenants require that the entire free cash fl ow be dedicated to debt rvice, the amount of debt outstanding and, therefore, the interest tax shield at any point in time are a direct function of the operating cash fl ows of the fi rm. Becau the debt balance is then as risky as the cash fl ows, the required return on asts should be ud to discount the
i nterest tax shields.4
A signifi cant portion of this debt was of the payment in kind (PIK) variety, which offers lenders additional bonds instead of cash interest. This PIK debt fi nancing provided KKR with signifi cant tax shields while allow-ing it to postpone the cash burden of debt rvice to future years. For simplicity of prentation, Table 17A.2 does not parately show cash versus noncash interest charges.
Table 17A.1
RJR Operating Cash Flows (in $ millions)
1989
1990199119921993 Operating income
$2,620
$3,410$3,645$3,950$4,310T ax on operating income 8911,1421,2221,3261,448Aftertax operating income 1,7292,2682,4232,6242,862 Add back depreciation 449475475475475 Less capital expenditures
意大利语入门522512525538551 Less change in working capital (203)(275)200225250 Add proceeds from ast sales 3,5451,805Unlevered cash fl ow (UCF)
$5,404
$4,311
$2,173
$2,336
$2,536
Table 17A.2
xianyanProjected Interest Expens and Tax Shields (in $ millions)
1989
1990199119921993Interest expens
$3,384$3,004$3,111$3,294$3,483Interest tax shields (t C ϭ 34%)
1,151
1,021
1,058
1,120
1,184
Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A-3
3 percent after 1993. The value, as of the end of 1993, of the cash fl ows is equal to the following discounted value of a growing perpetuity:
2.536(1.03) __________ 0.14 Ϫ 0.03
ϭ $23.746 billion This translates to a 1988 value of:
23.746 ______1.14
5 ϭ $12.333 billion As in Step 1, the discount rate is the required ast rate of 14 percent.
The total unlevered value of the fi rm is therefore $12.224 ϩ $12.333 ϭ $24.557 billion. To calculate the total buyout value, we must add the interest tax shields expected to be realized by debt fi nancing.St ep 3: Calculating the prent value of interest tax shields for 1989–1993 Under the prevailing U.S. tax laws in 1989, every dollar of interest reduced taxes by 34 cents. The p rent value of the interest tax shield for the period from 1989–1993 can be calcu-lated by discounting the annual tax savings at the pretax average cost of debt, which was
a pproximately 13.5 percent. Using the tax shields from Table 17A.2, the discounted value of the tax shields is calculated as:
1.151 _____1.135
ϩ 1.021 ______ 1.135
2 ϩ 1.058 ______ 1.135
responsible是什么意思
3 ϩ 1.120 ______ 1.135kiss是什么词
4 ϩ 1.184 ______ 1.135
5 ϭ $3.834 billion Step 4: Calculating the prent value of interest tax shields beyond 1993 Finally, we
must calculate the value of tax shields associated with debt ud to finance the operations of the company after 1993. We assume that debt will be reduced and maintained at 25 percent
Table 17A.3
RJR LBO Valuation (in $ millions except share data)
1989
1990199119921993
Unlevered cash fl ow (UCF)
$ 5,404
$4,311brothers
$2,173
$2,336$ 2,536
T erminal value: (3% growth after 1993) Unlevered terminal value (UTV)23,746 T erminal value at target debt 26,654 T ax shield in terminal value 2,908Interest tax shields
1,1511,0211,0581,120
1,184
PV of UCF 1989–1993 at 14%12,224PV of UTV at 14%12,333T otal unlevered value
$24,557PV of tax shields 1989–1993 at 13.5%3,834PV of tax shield in TV at 13.5%1,544T otal value of tax shields 5,378 T otal value 29,935 Less value of assumed deb t 5,000Value of equity $24,935Number of shares 229 million Value per share
$ 108.9
yadu17A-4 Part IV Capital Structure and Dividend Policy
of the value of the firm from that date forward.5 Under this assumption it is appropriate to u the WACC method to calculate a terminal value for the firm at the target capital struc-ture. This in turn can be decompod into an all-equity value and a value from tax shields. If, after 1993, RJR us 25 percent debt in its capital structure, its WACC at this target capital structure would be approximately 12.8 percent.6 Then the levered terminal value as of the end of 1993 can be estimated as:
2.536(1.03) ___________ 0.128 Ϫ 0.03
ϭ $26.654 billion Becau the levered value of the company is the sum of the unlevered value plus the
value of interest tax shields, it is the ca that: Value of tax shields (end 1993) ϭ V L (end 1993) Ϫ V
U (end 1993)
ϭ $26.654 billion Ϫ $23.746 billion
ϭ $2.908 billion
To calculate the value, as of the end of 1988, of the future tax shields, we again discount by the borrowing rate of 13.5 percent to get:7
2.908 ______ 1.135
5 ϭ $1.544 billion The total value of interest tax shields therefore equals $3.834 ϩ $1.544 ϭ $5.378 billion.
Adding all of the components together, the total value of RJR under the buyout
p roposal is $29.935 billion. Deducting the $5 billion market value of assumed debt yields a value for equity of $24.935 billion, or $108.9 per share.
Concluding Comment s about LBO Valuat ion Met hods As mentioned in this c hapter, the WACC method is by far the most widely applied approach to capital b udgeting.
5
This 25 percent fi gure is consistent with the debt utilization in industries in which RJR Nabisco is involved. In fact, that was the debt-to-total-market-value ratio for RJR immediately before management’s initial buyout proposal. The fi rm can achieve this target by 1993 if a signifi cant portion of the convertible debt ud to fi nance the buyout is exchanged for equity by that time. Alternatively, KKR could issue new equity (as would occur, for example, if the fi rm were taken public) and u the proceeds to retire some of the outstanding debt.6
To calculate this rate, u the weighted average cost of capital from this chapter:
R W ACC ϭ S ______ S ϩ B R S ϩ B ______ S ϩ B R B (1 Ϫ t C )and substitute the appropriate values for the proportions of debt and equity ud, as well as their respective costs.
无论如何英语Specifi cally, at the target debt-to-value ratio, B ͞(S ϩ B ) ϭ 25 percent, and S ͞(S ϩ B ) ϭ (1 Ϫ B ͞(S ϩ B )) ϭ 75 percent. Given this blend:
R S ϭ R 0 ϩ B __S (1 Ϫ t C ) (R 0 Ϫ R B ) ϭ 0.14 ϭ 0.25
____0.75(1 Ϫ 0.34) (0.14 Ϫ 0.135) ϭ 0.141
Using the fi ndings plus the borrowing rate of 13.5 percent in R W ACC , we fi
nd:R W ACC ϭ 0.75(0.141) ϩ 0.25(0.135)(1 Ϫ 0.34)
ϭ 0.128
In fact, this value is an approximation to the true weighted average cost of capital when the market debt-to-value blend is constant or when the cash fl ows are growing. For a detailed discussion of this issue, e Isik Inlbag and Howard Kaufold, “A Comparison of Alternative Discounted Cash Flow Approaches to Firm Valuation,” The Wharton School, University of Pennsylvania (June 1990), unpublished paper.7
A good argument can be made that becau post-1993 debt levels are proportional to fi rm value, the tax shields are as risky as the fi rm and should be discounted at the rate R 0.
Chapter 17Valuation and Capital Budgeting for the Levered Firm 17A-5 We could analyze an LBO and generate the results of the cond ction of this appendix using this technique, but it would be a much more diffi cult process. We have tried to show that the APV approach is the preferred way to analyze a transaction in which the capital structure is not stable over time.
Consider the WACC approach to valuing the KKR bid for RJR. We could discount the operating cash fl ows of RJR by a t of weighted average costs of capital and arrive at the same $30 billion total value for the company. To do this, we would need to calculate the appropriate rate for each year becau the WACC ris as the buyout proceeds. This occurs becau the value of the tax subsidy declines as debt principal is repaid. In other words, no single return reprents the cost of capital when the firm’s capital structure is changing.
There is also a theoretical problem with the WACC approach to valuing a buyout. To calculate the changing WACC, we must know the market value of a fi rm’s debt and equity. But if the debt and equity values are already known, the total market value of the company is also known. That is, we must know the value of the company to calculate the WACC. We must therefore resort to using book value measures for debt and equity, or make assump-tions about the evolution of their market values, to implement the WACC method.
