1
VALUATION: THE VALUE OF CONTROL
Control is not always worth 20%.
Set Up and Objective
1: What is corporate finance
2: The Objective: Utopia and Let Down
3: The Objective: Reality and Reaction
The Investment Decision
Invest in assets that earn a return
greater than the minimum acceptable
hurdle rate
Hurdle Rate
4. Define & Measure Risk
5. The Risk free Rate
6. Equity Risk Premiums
7. Country Risk Premiums
8. Regression Betas
9. Beta Fundamentals
10. Bottom-up Betas
11. The "Right" Beta
12. Debt: Measure & Cost
13. Financing Weights
The Financing Decision
Find the right kind of debt for your
firm and the right mix of debt and
equity to fund your operations
Financing Mix
17. The Trade off
18. Cost of Capital Approach
19. Cost of Capital: Follow up
20. Cost of Capital: Wrap up
21. Alternative Approaches
22. Moving to the optimal
Financing Type
23. The Right Financing
Investment Return
14. Earnings and Cash flows
15. Time Weighting Cash flows
16. Loose Ends
2
36. Closing Thoughts
The Dividend Decision
If you cannot find investments that make
your minimum acceptable rate, return the
cash to owners of your business
Dividend Policy
24. Trends & Measures
25. The trade off
26. Assessment
27. Action & Follow up
28. The End Game
Valuation
29. First steps
30. Cash flows
31. Growth
32. Terminal Value
33. To value per share
34. The value of control
35. Relative Valuation
Disney: Inputs to Valuation
3
High Growth Phase
Length of Period
Tax Rate
Transition Phase
5 years
5 years
Stable Growth Phase
Forever after 10 years
31.02% (Effective)
31.02% (Effective)
31.02% (Effective)
36.1% (Marginal)
36.1% (Marginal)
36.1% (Marginal)
Return on Capital
12.61%
Declines linearly to 10%
Stable ROC of 10%
Reinvestment Rate
53.93% (based on normalized Declines gradually to 25% 25% of after-tax operating
acquisition costs)
as ROC and growth rates income.
drop:
Reinvestment rate = g/ ROC
= 2.5/10=25%
Expected
Growth ROC * Reinvestment Rate = Linear decline to Stable 2.5%
Rate in EBIT
0.1261*.5393 = .068 or 6.8%
Growth Rate of 2.5%
Debt/Capital Ratio
11.5%
Rises linearly to 20.0%
20%
Risk Parameters
Beta = 1.0013, ke = 8.52%%
Beta changes to 1.00;
Beta = 1.00; ke = 8.51%
Pre-tax Cost of Debt = 3.75%
Cost of debt stays at 3.75% Cost of debt stays at 3.75%
Cost of capital = 7.81%
Cost of capital declines Cost of capital = 7.29%
gradually to 7.29%
3
4
5
Ways of changing value…
6
Are you investing optimally for
future growth?
How well do you manage your
existing investments/assets?
Cashflows from existing assets
Cashflows before debt payments,
but after taxes and reinvestment to
maintain exising assets
Are you building on your
competitive advantages?
Are you using the right
amount and kind of
debt for your firm?
Growth from new investments
Growth created by making new
investments; function of amount and
quality of investments
Efficiency Growth
Growth generated by
using existing assets
better
Expected Growth during high growth period
Is there scope for more
efficient utilization of
exsting assets?
Stable growth firm,
with no or very
limited excess returns
Length of the high growth period
Since value creating growth requires excess returns,
this is a function of
- Magnitude of competitive advantages
- Sustainability of competitive advantages
Cost of capital to apply to discounting cashflows
Determined by
- Operating risk of the company
- Default risk of the company
- Mix of debt and equity used in financing
6
7
The value of control
8

We have two values for Disney.
The status quo value per share, run by existing
management with its current policies in place, is $62.56.
 The “optimal” value, with changes to investing, financing
and dividend policy yields a value per share of $74.91


The difference between the two values can
legitimately be called the value of control.

Value of control = $74.91 - $62.56 = $ 12.35/share
8
Implications
9
The value of control should be greater at poorly managed
firms than well run firms.
The market price of a company should reflect the expected
value of control, which incorporates the probability that
management will change.
1.
2.
a.
b.
If corporate governance is so weak that there is no chance of
management change, the expected value of control should go to zero
and the stock price should converge on the status quo value.
In the event of a control change (an acquisition or an activist investor
waging a control battle), the likelihood of management change will
increase and the stock should trade at close to its optimal value.
9
Task
Estimate the
status quo &
optimal values
for your firm, and
the value of
control
10
Read
Chapter 12