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RJR Nabisco - Case Questions

The document contains questions for a case study on the leveraged buyout of RJR Nabisco. It asks students to: 1. Estimate the expected return on RJR Nabisco's assets using information on betas and capital structure. 2. Calculate the total value of RJR Nabisco under its pre-bid operating strategy using APV. 3. Compare the total values of RJR Nabisco under its pre-bid strategy, the management group's strategy, and KKR's strategy. It provides hints on assumptions to use in the valuations, such as a debt beta of 0, risk free rate of 9%, and terminal growth rate of 2-4%.

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511 views2 pages

RJR Nabisco - Case Questions

The document contains questions for a case study on the leveraged buyout of RJR Nabisco. It asks students to: 1. Estimate the expected return on RJR Nabisco's assets using information on betas and capital structure. 2. Calculate the total value of RJR Nabisco under its pre-bid operating strategy using APV. 3. Compare the total values of RJR Nabisco under its pre-bid strategy, the management group's strategy, and KKR's strategy. It provides hints on assumptions to use in the valuations, such as a debt beta of 0, risk free rate of 9%, and terminal growth rate of 2-4%.

Uploaded by

Jorge Smith
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Finance II (431) Professor Ponticelli

RJR Nabisco – Case Questions

Answer the following questions on Canvas:

1. Consider the sources of value creation in LBOs. Is RJR Nabisco a good target for an LBO?

2. Utilizing information on estimated betas and capital structure from Exhibits 2 and 3 for 1986
and 1987, provide an estimate for the expected return on the firm’s assets. (If your answer is
seven and a half percent, enter your answer as 7.5)

3. Using APV and the return on assets estimated above, what is the total value of RJR Nabisco
under the pre-bid operating strategy? (Enter your answers in millions of dollars)

In class we will also discuss the questions below. Read them, discuss them (in groups, whenever
possible) and, if you are in the mood for a big LBO, do the math. When doing your valuations,
please first read the hints contained in the next page.

 What is the total value of RJR Nabisco under:

(a) The pre-bid operating strategy?


a. To do this valuation, look at the hints in the next page, and use APV to calculate
RJR Nabisco’s value

(b) The Management Group’s operating strategy?


a. You may want to use CCF to do your valuation.

(c) KKR’s operating strategy?


a. You may want to use CCF to do your valuation.

 What accounts for differences in the values under these three scenarios?

 If you were on the Special Committee, what would you do?


In doing your valuations, consider the following assumptions/hints

 Be careful when calculating the FCF: The line item “Cash flow available for capital
payments” is the total cash flows that are available for shareholders. We must think
carefully about how to get the total cash flows to investors and how to take into account
the debt tax shields. Our APV valuation technique is much easier and flexible to use here.

Exhibit 5 does not provide information on EBIT. To calculate FCF, recall that:

Net income = (EBIT – Interest) (1 – τ)

Thus,

EBIT = [Net income / (1 – τ)] + Interest

 To estimate the cost of capital, calculate the beta from figures in Exhibit 2 and 3 by
averaging the appropriate betas in the last two years. You can use book value of debt as a
proxy for market value.

 Assume the debt beta of RJR Nabisco from 1986 to 1987 is 0

 You can assume that the risk free rate is 9%, the risk premium is 8%, and the tax rate is
34%.
 A reasonable estimate of terminal growth rate is 2-4%.

 Consider how to appropriately discount the debt tax shield cash flows—the firm runs with
a given leverage ratio, but we use APV as our valuation technique.

 Recall that CCF is a compressed version of APV. As we saw in Lecture 3,

VFirm= NPV [FCF|r = rA] + NPV [Financing]

VFirm, CCF = ∑ ∑

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