The following information is available about Chiantivino Corp. (CC): An activist
ID: 2750334 • Letter: T
Question
The following information is available about Chiantivino Corp. (CC):
An activist investor is confident that by terminating CC’s money-losing fortified wine division, she can increase free cash flow by $4 million annually for the next decade. In addition, she estimates that an immediate, special dividend of $10 million can be financed by the sale of the division.
Show your answer if you conduct a sensitivity analysis by assuming the cost of capital is 15 percent and the increased cash flow is only $3.5 million per year.
Explanation / Answer
a) The maximum justifiable premium =the fair marekt value of CC under new management -the fair marekt value of CC under existing management
the fair marekt value of CC under existing management =Current market value of firm + market value of interest bearing debt
=8*10+75
=$ 155 millions
the fair marekt value of CC under new management = $ 155 millions+present value of enhancements
=$ 155 millions+$4 million * PVAF@14% for 10 years+$10 million for sale of division
= 155+4*5.216+10
Fair market value of business =$ 185.86 millions
Fair market value of equity =$ 185.86 millions-75 million
=$ 110.86 millions
Fair market value of equity per share = $ 110.86 millions/10
=$ 11.09 per share
Premium over the existing price($ 8) = 38.6%
Fair market value of the firm assuming a 15 % discount rate and a $ 3.5 million annuity = 155+3.5(5.019)+10
=$ 182.57 million.
Value of equity =$ 182.57 million.-$ 75 million
=$ 107.57 million
Value per share =107.57/10
=$v10.76 per share
Premium over the existing price($ 8) = 34.5%
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