1. RJR Nabisco
Some genius invented the Oreo. We’re just living off of the inheritance.
F. Ross Johnson

2. Fair Market Value
Fair Market Value: “…the price at which the asset would trade between two rational individuals, each in command of all of the information necessary to value the asset, and neither under any pressure to trade.”
Rocky Higgins Analysis for Financial Management (p. 318)

3. Capital Budgeting 101 Step 1: Estimate Discount Rate
Step 2: Project Cash Flows
Cash flows for in tables
Terminal value
Step 3: Compute Net Present Value (NPV)
Accept positive NPV projects

4. Discount Rate where t = tax rate,
As we discussed, the discount rate is the weighted average cost of capital (WACC).
where t = tax rate,
E(rd) = expected cost of debt
D = amount of debt in capitalization
E(re) = expected cost of equity
E = amount of equity capitalization

5. Discount Rate
To calculate the WACC using 1989 figures under the three strategies:
NOTE: since the capital structure changes over time, we need to recompute the WACC each year to reflect the change in capital structure.

6. Projected Cash Flows
Projected cash flows for 1989 are calculated as follows:

7. Projected Cash Flow
The following cash flow represent the cash flow computed from the tables:

8. Terminal Value
To estimate a terminal value, we need to make an assumption about future growth after 1998.
If cash flows grow by 2.5% per year (and the WACC remains constant), then for the pre-bid strategy:
For the Management Group scenario:
For the KKR scenario:

9. Terminal Value Results will depend on the growth rate assumption.
Values in 1998 of cash flows for 1999 and beyond for different assumptions are (“Sensitivity Analysis”):
Growth Rate

10. Present Value
The present value of the cash flows for the prebid strategy is (using the 2.5% growth rate assumption after 1998): ($ millions)
This represents the total value of RJR Nabisco (ASSETS).

11. Present Value
To figure out the value per share of RJR Nabisco to the CURRENT shareholders, consider the pre-bid valuation:
Total Assets = 22,607
Current Debt = 5,204
Equity = 17,403

12. Valuation
Estimates of the value per share under the alternatives (again, using the 2.5% growth rate assumption):

13. Sources of Value
The company is worth substantially more under either the KKR or the Management Group plan.
There are smaller differences between the KKR value and the management value.
The buyout plans propose to
increase debt
trim excesses
decrease capital expenditures
sell food assets
decrease operating profits
All gains are based on projections.

14. What Happened? Per share bids: Case (11/18) 11/29/88 MGMT $100 $101
KKR FB

15. Activities of Special Committee
Concluded that First Boston bid was impractical.
Began to negotiate terms with KKR.
Letter from Management Group protesting negotiations with KKR, offering to negotiate all aspects of its proposal.
Special Committee decided to consider new bids.

16. Activities of Special Committee
Summary of final bids (substantially equivalent):
Bid Valuation
MGMT $ $108
KKR
Chose KKR:
more equity (25% vs 15% for mgmt)
retain more businesses
fewer PIK securities
more benefits to terminated employees.

17. Summary: RJR Nabisco
Fundamentals of firm valuation: discounted cash flow techniques.
Relation between managerial decisions and firm cash flows.
Operating decisions can create or destroy value.
Role of a corporate governance system that encourages value-enhancing decisions.