BFN3104

Chapter 10
Questions
1.

Define these terms:

Assets-in-place Asset on place also known as operating assets, include the land,
buildings, machines and inventory that firm uses in its operation to produce its
products and services.
Growth options Growth option are not tangible. They include items such as R&D
and customer relationship.
Non-operating assets Financial or non-operating assets include investments in
marketable securities and non-controlling interests in the stock of other companies.
Value of operations The value of operations is the present value of all the future
free cash flow that are expected from current assets-in-place and the expected growth
of assets-in-place when discounted at the weighted average cost of capital.

Horizon value The terminal or horizon value is the value of operations at the end of
the explicit forecast period. It is equal to the present value of all free cash flows
beyond the forecast period, discounted back to the end of the forecast period at the
weighted average cost of capital.

Corporate valuation model The corporate valuation model defines the total value
of a company as the value of operations plus the value non-operating assets plus the
value of growth options.
Value-based management Value Based Management is the management approach
that ensures corporations are run consistently on value (normally: maximizing
shareholder value).
Value drivers Entities that increase the value of a product or service by improving
the perception of the item and essentially providing a competitive advantage. Value
drivers can come in many forms such as cutting-edge technology, brand recognition,
or satisfied customers.

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BFN3104
ROIC - A measure of how effectively a company uses the money (borrowed or
owned) invested in its operations. Calculated by: net income after taxes / (total assets
less excess cash minus non-interest-bearing liabilities).
2.

Explain how it is possible for sales growth to decrease the value of a profitable
company.
A company can be profitable and yet have an ROIC that is less than the WACC if the
company has large capital requirements. If ROIC is less than the WACC then the
company is not earning enough on its capital to satisfy its investors. Growth adds
even more capital that is not satisfying investors, hence growth decreases value.

Problems
3.

Brooks Enterprises has never paid a dividend. Free cash flow is projected to be
RM80,000 and RM100,000 for the next 2 years, respectively, and after the second
year it is expected to grow at a constant rate of 8 percent. The companys weighted
average cost of capital is WACC=12 percent.
a.

What is the terminal value or horizon value of operations?

b.

Calculate the value of Brooks operation.

.
0

1(80000) 2(100000)

3(108000)

Present Value
RM 71428.57 (80000*1.12)
RM 79719.39 (100000*1.12^2)
RM 2152423.47 (2.7million*1.12^2)
RM 2303571.43

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4. You are given the following forecasted information for the year 2007:
Sales: RM300,000,000
Operating profitability (OP): 6%
Capital requirement (CR): 43%
Growth (g): 5%
WACC: 9.8%
If these values remain constant, what is the horizon value (that is the 2007 value of
operations)? Calculate the MVA assuming this is a constant growth firm.

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