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    RJR Nabisco - Case Questions

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    Jorge Smith
    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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    RJR Nabisco - Case Questions

    Uploaded by

    Jorge Smith
    287 views2 pages
    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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    RJR Nabisco Case Questions

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    RJR-Questions

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    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%.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    287 views2 pages

    RJR Nabisco - Case Questions

    Uploaded by

    Jorge Smith
    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%.

    Copyright:

    © All Rights Reserved
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    of 2

    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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