RJR Nabisco Valuation
When assessing the valuation of RJR Nabisco bids, the Special committee should utilize the Capital Cash Flow method. The Capital Cash Flow method, when applied appropriately, should yield the same valuation when discounting a company’s Free Cash Flow. To get Capital Cash Flows (CCF), Net Income is adjusted by adding back non-cash expenses and other reconciliations to form cash flow, decreasing Capital Expenditures, decreasing changes in Net Working Capital and finally, adding Cash Interest. The Capital Cash Flow Method is algebraically equivalent to the Free Cash Flow Method because the CCF’s are discounted by the Expected Asset Return (Ka) and not by the Weighted Average Cost of Capital. The key advantage with the use of the CCF method is that the valuations do not require Year over Year changes in the discount rate if the capital structure of a company is projected to change. In particular, it is useful when valuing Leveraged Buyout Scenarios because the discount rate for each year is the same even though a firm’s capital structure may be go from being extremely to lowly levered over the investment horizon. As shown in Exhibit 1, 2, and 3, the enterprise values of RJR Nabisco are calculated by summing the discounted capital cash flows with the terminal value. By discounting the CCF’s by the Expected Asset Return of 12.32% (exhibit 4), the enterprise value of RJR Nabisco under the pre-bid, management-bid, and KKR-bid strategies are $27.9 billion, $37.5 billion, and $39.5 billion, respectively.
Difference in Value of the Three Operating Plans
The difference between pre-bid, KKR, and the Management Group’s valuations is due to the variations in operating strategies. The pre-bid strategy assumes that the current company structure is continues into the foreseeable future. Since it is not a leveraged buyout, RJR Nabisco is valued with no added debt in the capital structure. Its enterprise value is simply determined by discounting the...
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