Fin 620: Financial Administration Policies
Case Analysis on
RJR Nabisco Towards a course in Finance – FIN 620: Financial Administration Policies
Submitted by Benjamin T. Schultz, Gail Olsen & Raj K Bhutani To Dr. Susan E. Moeller
Eastern Michigan University, Ypsilanti, Michigan
Table of Contents
I Problem Statement 3 II Analysis of Economic and Industry Data 3 II.1 What is LBO? 3 II.2 RJR and Smoking 3 III Analysis of Alternative Solutions 4 III.1 Strengths of KKR: 4 III.2 Weaknesses of KKR 5 III.3 Opportunities for KKR 5 III.4 Threats for KKR 5 III.5 Share Value: Pre-Bid offer 5 III.6 Share Value: Management group offer 6 III.7 Share Value: KKR offer 6 IV Recommendations 7 V Appendix – Exhibits 8
Problem Statement …show more content…
On October 20, 1988, Charles E. Hugel, chairman of RJR Nabisco, was appointed to consider a proposal to purchase the company for $17 billion, at $75 a share, by Management Group, consisting of F. Ross Johnson, President and CEO of RJR Nabisco; Edward A. Horrigan, Vice Chairman of RJR Nabisco and CEO of RJ Reynolds Tobacco Company; and investment banking firm of Shearson Lehman Hutton. Within four days, Kohlberg, Kravis, Roberts & Co. (KKR) announced a competing offer of $90 a share.
Determining the value of RJR Nabisco is the crux of this case.
Refer to the case “RJR Nabisco” from text book “Case Problems in Finance” by Kester, Carl W., Ruback, Richard S. and Tufano, Peter, ISBN: 0-07-294551-6, pp 667-676.
The question central to this case is: What is the true value of RJR Nabisco?
Analysis of Economic and Industry Data
The concept of leveraged buy-outs (LBO) was relatively new in 1988. The first LBO occurred in 1964 when Jerome Kohlberg, Jr. and Henry Kravis acquired the Orkin Extermination Company. Since then there had been an accelerating trend of LBO’s (See Exhibit 1)
What is LBO?
LBO’s allow a small group of investors or other private parties to purchase large firms using the purchased firm’s debt potential to raise the funding necessary for the purchase. The disadvantage of this process is that it leaves the buyers with a company that has an enormous amount of debt on its books. Despite this, LBO’s have been successfully transacted in the past with substantial profits ending up in the pockets of the buyers. It is for this reason that companies with little existing debt and an undervalued stock price become the target for a leveraged buyout.
RJR and Smoking
RJR Nabisco was considered by many to be undervalued in 1988. At that time there was increasing public pressure to regulate tobacco more stringently, as well as more and more data coming to the fore describing the health risks inherit in using tobacco products.
In the years immediately preceding the buyout of RJR Nabisco, there were several prevalent news stories that painted a very poor picture of the tobacco industry.
* The grandson of RJR’s founder, Patrick Reynolds, urged at a House Congressional hearing that he believed that tobacco advertising should be banned and described watching his father die of …show more content…
emphysema. * In 1987, the “Marlboro Man” David Millar Jr. died of emphysema. * In 1988 Surgeon General C. Everett Coop famously and exhaustively reported on the negative health effects of tobacco use. * Cities had begun banning smoking in restaurants and federal regulatory agencies had begun banning smoking in government buildings and airline travel.
All of these factors generated a very negative view regarding tobacco in general and tobacco companies in particular.
Despite the country’s increasingly negative opinion of tobacco, sales had remained strong enough to generate significant profits. While overall cigarette production was down from its peak in 1981, it had remained steady for the five years leading up to 1988 (see Exhibit 2).
Perhaps the clearest indication of potential profit in the tobacco industry at that time was the manufacture value added (equal to selling price minus the cost of materials) by the tobacco industry. While some of this difference went to marketing, production, distribution and administration, there was still plenty of value left for huge profit margins, and that value was increasing year by year (see Exhibit 3).
In contrast to the tobacco industry, the food industry operates on a much lower level of profit margin. In the years leading to the RJR buyout, there were increases in the industry’s profit per dollar sold, but the amounts were still relatively low when compared to tobacco (see Exhibit 4).
In early 1988, despite its low stock price, the financial health of RJR Nabisco was excellent,. Operating income had increased by an average of 15.85% over the previous five years. Its Net Income also showed steady improvement over that time frame, averaging 8.35% growth per year (see Exhibit 5).
Analysis of Alternative Solutions
Strengths of KKR
KKR invented the LBO and had a strong presence in the field of corporate acquisitions. It was a very professionally managed business with a history of sound decision making. Their experience allowed them to master the art of identifying an under-value company with strong potential and, at appropriate time, offering a suitable price to acquire it. After acquisition, KKR would put an efficient management team in place and sell off the inefficient parts of the business, creating a higher value for its shareholders who are in this case KKR and its team of investment bankers. As of 1988, KKR had already identified RJR Nabisco as a candidate for a LBO.
Weaknesses of KKR
The major weakness for KKR in developing their bid strategy was the understandable reticence of the Management Group to fully disclose the numbers involved with RJR Nabisco’s finances.
Opportunities for KKR
The acquisition of RJR Nabisco was an attempt by KKR to increase their holdings in the US manufacturing sector. They saw a great opportunity to acquire RJR Nabisco at a undervalued price and then eliminate the inefficiencies and grow the organization. KKR planned on pursuing new avenues with management style and personnel upon completion of the LBO.
Threats for KKR
Henry Kravis first present the case for an RJR Nabisco buyout to F. Ross Johnson. F. Ross Johnson later represented Management group to make offer LBO for RJR Nabisco. The Management group’s bid came before KKR could submit their first offer. Due to internal influence and internal know-how, Management group had slightly higher chances of winning the bid. Furthermore, this was the largest LBO offer to date and even KKR hadn’t attempted just a large LBO.
Share Value: Pre-Bid offer
First we determined the pre-bid price per share value. We calculated the cost of equity using Gordon’s Growth Dividend Model and the Cost of Capital Model for an average cost of equity of 14.22% (see Exhibit 10).
Using the dividend growth model, we determined the earnings per share between 1982 and 1987 having an arithmetic mean of 10.21%. With the price of stock in 1986 at $45.00 and dividends paid in 1987, we were able to show a result of 14.52% for this model.
The cost of equity using, CAPM was determined using the T-Bond rate of 8.93% in 1988, the provided Beta and the risk premium from Ibbotson, and the value of 14.52% was obtained
(see Exhibit 11).
The results were then used for WACC computation.
The preferred stock cost of 12.52% was an assumption using the average cost of debt and cost of equity, as this was not provided or easily determined. The WACC was calculated at 11.22% using a corporate tax rate of 40% (see Exhibit 12).
The Free Cash Flows with inflation rate in 1988 at 4.08% and terminal value calculated using the WACC we generated a present value of $28,297.92 for a price per share value of $114.38 for the periods of 1989 through 1993. A five-year period was used rather than a ten-year period, because after five years, forecasting is not practical. Capital expenditures were subtracted and depreciation was added (as provided) and used for the Free Cash Flows. Net Working Capital was not part of the cash flows as we can assume that changes in cash flow, inflation and depreciation will make the changes in Net Working Capital negligible. We did not consider development expenses of $300 million on “Premier” in our calculations, as these expenses are sunk cost.
Share Value: Management group offer
Next, we determined the value of the price per share for Management Group (MG). We began with the cost of debt. We looked at 1989 by taking the interest expense and non-cash expense (as we considered this a part of debt) and divided it by the long-term debt to see if we could get a reasonable percentage, however we obtained 24.96%. This was obviously too high. Then we considered the activity that MG had in 1989. With the debt of the buy-out and the sale of the food industry occurring in 1989, we decided 1990 would be a better determinant in our calculation after the operations became stable. We did the same calculation for 1990 and obtained 12.77%.. We obtained the rates of Baa corporate bonds in 1988 and saw that they averaged 10.83%. We concluded that our 12.77% cost of debt was a reasonable percentage, considering the amount of debt MG projected to generate (see Exhibit 14).
To determine the cost of equity using CAPM, we used a number approaches. We first took the pre-bid beta and un-leveraged and re-leveraged and obtain 3.38 and 2.77 for 1989 and 1990 respectfully for MG (see Exhibit 14).
Again we considered 1990 in our analysis as we thought this may show a better reflection due to the volatility of 1989 transactions.
However, we considered these betas to be too high, the cause of which we traced to the high level of debt. We then looked at the beta for Philip Morris (.88) in 1988 as a pure play substitute. This was an appropriate decision, as MG’s strategy was to sell the food division and maintain the tobacco division alone. After group discussion, we opted to use a beta of 1.2, lower than 2.77, as that was unreasonably high, but higher than 1, as a company with that much debt will inherently have more risk than the market as a whole (see Exhibit
15).
With our previous bond yield and risk premium, cost of equity was 17.85% (see Exhibit 16). When combining the debt, equity cost and cost of preferred stock (average between debt and equity costs) we obtained 10.56% for the WACC. This result was figured using an effective tax rate of 34%. We used a lower tax rate than the pre-bid, as the Management Group will have more interest expenses, resulting in a lower effective tax rate (see Exhibit 17).
The Free Cash Flows (see Exhibit 18) follow the same formulae as the pre-bid; after tax income, add amortization and depreciation, proceeds of sales in the first year less capital expenditures and no working capital. The same inflation rate of 4.08% was used for terminal value and our WACC was calculated to be 10.56%. The present value of the cash flows and terminal value discounted using the WACC resulted in a present value of $35,298 for a price per share of $142.68.
Share Value: KKR offer
Last, we analyzed Kohlberg, Kravis, Roberts & Co. (KKR) strategy. For the cost of debt calculation we looked at both 1989 and 1990 to see if there was any significant changes from one year to the next (see Exhibit 19). However we felt that 1989 was a fair representation of their debt as there were no material changes from the two years. We also added into the debt calculation non-cash expense as a means to capture all potential expenses related to debt in order to obtain a cost. The calculation resulted in a cost of debt of 15.63%.
For this analysis, we also looked at un-leveraging and re-leveraging the beta for both 1989 and 1990. Again, we were not comfortable with the betas of 6.74 and 4.80 for those years
(see Exhibit 20). After some debate and consideration of the larger amount of debt KKR will carry throughout their strategy, we chose to use 1.40 as our beta.
We did considered the fact that beta is not a perfect measure of risk, but is rather a measure of how the stock price moves in relation to its market and concluded that for this purpose, the beta of KKR should be slightly higher than that of MG as KKR will be beholden to a much larger proportion of debt
The cost of equity was calculated by simply taking our previous bond yield rate; risk premium and our current beta to reach a cost of equity of 19.33% (see Exhibit 21).
Using the cost of debt, cost of equity and average of the two costs to obtain a preferred stock cost weighted with an effective tax rate of 34% we formulated a WACC of 11.70% (see Exhibit 22).
We then performed the same calculation using after tax income, adding amortization and depreciation, proceeds of sales in the first year and second year less capital expenditures and no working capital as we did in MG to obtain our Free Cash Flows for five years (see Exhibit 23).
We then performed the necessary operations and obtained our terminal value. Combining both the terminal value and the cash flows discounted at 11.70% (WACC) we achieved a price per share of $120.33.
Overall we felt that our price per share of stock was on the high side due to the large amount of debt the two proposals were assuming. Much of this had to do with the tax benefits of carrying so much debt, and our inability to find an accurate cost of that debt. If finance is more art than science, and art is the study of beauty, and beauty is truth, then our finance can therefore be considered true and we can move on with a clear conscience. QED.
Recommendations
Taking into consideration the results of Management Group’s (MG) share value of $142.68 and KKR’s share value of $120.33, we opted for recommending KKR. The reasoning behind this decision lies with KKR’s experience with leverage buy-outs, expertise in operations, and maintaining companies as a whole. MG had no experience in such matters and their plan relied wholly upon the sale of Nabisco for the price they had projected.
Appendix – Exhibits
Exhibit 1
Exhibit 2 Cigarette Production
Cigarette Production (Billions) | 1970 | 583 | | 1975 | 651 | | 1979 | 704 | | 1980 | 714 | | 1981 | 737 | | 1982 | 694 | | 1983 | 667 | | 1984 | 669 | | 1985 | 665 | | 1986 | 658 | | 1987 | 689 | |
Exhibit 3
(Cigarette Value Added Chart) Manufacturer Value Added, Cigarettes (Million Dollars) | Year | Sale | Cost of Materials | 1977 | 3803.1 | 2573.5 | 1978 | 3946.8 | 3076.7 | 1979 | 4670.6 | 3051.9 | 1980 | 5386.9 | 3670.6 | 1981 | 6536.3 | 4025.6 | 1982 | 8098.3 | 4052.3 | 1983 | 8624 | 3986 | 1984 | 9538 | 4403.3 | 1985 | 1054.07 | 4362.1 | 1986 | 11501.1 | 4205.2 | 1987 | 12970.7 | 4396.6 |
Exhibit 4
(Food Profit Chart) Food Profits per dollar of sales (cents) | 1970 | 2.5 | 1970 | | 1975 | 3.2 | 1975 | | 1980 | 3.4 | 1980 | | 1982 | 3.1 | 1982 | | 1983 | 3.3 | 1983 | | 1984 | 3.3 | 1984 | | 1985 | 4.1 | 1985 | | 1986 | 4.2 | 1986 | | 1987 | 4.6 | 1987 | |
Exhibit 5 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | Arithmetic Average | Operating income | 1,142 | 1,205 | 1,412 | 1,949 | 2,340 | 2,304 | | O.I Growth | | 5.52% | 17.18% | 38.03% | 20.06% | -1.54% | 15.85% | Net income | 870 | 881 | 1,210 | 1,001 | 1,064 | 1,209 | | N.I Growth | | 1.26% | 37.34% | -17.27% | 6.29% | 13.63% | 8.25% |
RJR Nabisco Towards a course in Finance – FIN 620: Financial Administration Policies
Submitted by Benjamin T. Schultz, Gail Olsen & Raj K Bhutani To Dr. Susan E. Moeller
Eastern Michigan University, Ypsilanti, Michigan
Table of Contents
I Problem Statement 3 II Analysis of Economic and Industry Data 3 II.1 What is LBO? 3 II.2 RJR and Smoking 3 III Analysis of Alternative Solutions 4 III.1 Strengths of KKR: 4 III.2 Weaknesses of KKR 5 III.3 Opportunities for KKR 5 III.4 Threats for KKR 5 III.5 Share Value: Pre-Bid offer 5 III.6 Share Value: Management group offer 6 III.7 Share Value: KKR offer 6 IV Recommendations 7 V Appendix – Exhibits 8
Problem Statement …show more content…
On October 20, 1988, Charles E. Hugel, chairman of RJR Nabisco, was appointed to consider a proposal to purchase the company for $17 billion, at $75 a share, by Management Group, consisting of F. Ross Johnson, President and CEO of RJR Nabisco; Edward A. Horrigan, Vice Chairman of RJR Nabisco and CEO of RJ Reynolds Tobacco Company; and investment banking firm of Shearson Lehman Hutton. Within four days, Kohlberg, Kravis, Roberts & Co. (KKR) announced a competing offer of $90 a share.
Determining the value of RJR Nabisco is the crux of this case.
Refer to the case “RJR Nabisco” from text book “Case Problems in Finance” by Kester, Carl W., Ruback, Richard S. and Tufano, Peter, ISBN: 0-07-294551-6, pp 667-676.
The question central to this case is: What is the true value of RJR Nabisco?
Analysis of Economic and Industry Data
The concept of leveraged buy-outs (LBO) was relatively new in 1988. The first LBO occurred in 1964 when Jerome Kohlberg, Jr. and Henry Kravis acquired the Orkin Extermination Company. Since then there had been an accelerating trend of LBO’s (See Exhibit 1)
What is LBO?
LBO’s allow a small group of investors or other private parties to purchase large firms using the purchased firm’s debt potential to raise the funding necessary for the purchase. The disadvantage of this process is that it leaves the buyers with a company that has an enormous amount of debt on its books. Despite this, LBO’s have been successfully transacted in the past with substantial profits ending up in the pockets of the buyers. It is for this reason that companies with little existing debt and an undervalued stock price become the target for a leveraged buyout.
RJR and Smoking
RJR Nabisco was considered by many to be undervalued in 1988. At that time there was increasing public pressure to regulate tobacco more stringently, as well as more and more data coming to the fore describing the health risks inherit in using tobacco products.
In the years immediately preceding the buyout of RJR Nabisco, there were several prevalent news stories that painted a very poor picture of the tobacco industry.
* The grandson of RJR’s founder, Patrick Reynolds, urged at a House Congressional hearing that he believed that tobacco advertising should be banned and described watching his father die of …show more content…
emphysema. * In 1987, the “Marlboro Man” David Millar Jr. died of emphysema. * In 1988 Surgeon General C. Everett Coop famously and exhaustively reported on the negative health effects of tobacco use. * Cities had begun banning smoking in restaurants and federal regulatory agencies had begun banning smoking in government buildings and airline travel.
All of these factors generated a very negative view regarding tobacco in general and tobacco companies in particular.
Despite the country’s increasingly negative opinion of tobacco, sales had remained strong enough to generate significant profits. While overall cigarette production was down from its peak in 1981, it had remained steady for the five years leading up to 1988 (see Exhibit 2).
Perhaps the clearest indication of potential profit in the tobacco industry at that time was the manufacture value added (equal to selling price minus the cost of materials) by the tobacco industry. While some of this difference went to marketing, production, distribution and administration, there was still plenty of value left for huge profit margins, and that value was increasing year by year (see Exhibit 3).
In contrast to the tobacco industry, the food industry operates on a much lower level of profit margin. In the years leading to the RJR buyout, there were increases in the industry’s profit per dollar sold, but the amounts were still relatively low when compared to tobacco (see Exhibit 4).
In early 1988, despite its low stock price, the financial health of RJR Nabisco was excellent,. Operating income had increased by an average of 15.85% over the previous five years. Its Net Income also showed steady improvement over that time frame, averaging 8.35% growth per year (see Exhibit 5).
Analysis of Alternative Solutions
Strengths of KKR
KKR invented the LBO and had a strong presence in the field of corporate acquisitions. It was a very professionally managed business with a history of sound decision making. Their experience allowed them to master the art of identifying an under-value company with strong potential and, at appropriate time, offering a suitable price to acquire it. After acquisition, KKR would put an efficient management team in place and sell off the inefficient parts of the business, creating a higher value for its shareholders who are in this case KKR and its team of investment bankers. As of 1988, KKR had already identified RJR Nabisco as a candidate for a LBO.
Weaknesses of KKR
The major weakness for KKR in developing their bid strategy was the understandable reticence of the Management Group to fully disclose the numbers involved with RJR Nabisco’s finances.
Opportunities for KKR
The acquisition of RJR Nabisco was an attempt by KKR to increase their holdings in the US manufacturing sector. They saw a great opportunity to acquire RJR Nabisco at a undervalued price and then eliminate the inefficiencies and grow the organization. KKR planned on pursuing new avenues with management style and personnel upon completion of the LBO.
Threats for KKR
Henry Kravis first present the case for an RJR Nabisco buyout to F. Ross Johnson. F. Ross Johnson later represented Management group to make offer LBO for RJR Nabisco. The Management group’s bid came before KKR could submit their first offer. Due to internal influence and internal know-how, Management group had slightly higher chances of winning the bid. Furthermore, this was the largest LBO offer to date and even KKR hadn’t attempted just a large LBO.
Share Value: Pre-Bid offer
First we determined the pre-bid price per share value. We calculated the cost of equity using Gordon’s Growth Dividend Model and the Cost of Capital Model for an average cost of equity of 14.22% (see Exhibit 10).
Using the dividend growth model, we determined the earnings per share between 1982 and 1987 having an arithmetic mean of 10.21%. With the price of stock in 1986 at $45.00 and dividends paid in 1987, we were able to show a result of 14.52% for this model.
The cost of equity using, CAPM was determined using the T-Bond rate of 8.93% in 1988, the provided Beta and the risk premium from Ibbotson, and the value of 14.52% was obtained
(see Exhibit 11).
The results were then used for WACC computation.
The preferred stock cost of 12.52% was an assumption using the average cost of debt and cost of equity, as this was not provided or easily determined. The WACC was calculated at 11.22% using a corporate tax rate of 40% (see Exhibit 12).
The Free Cash Flows with inflation rate in 1988 at 4.08% and terminal value calculated using the WACC we generated a present value of $28,297.92 for a price per share value of $114.38 for the periods of 1989 through 1993. A five-year period was used rather than a ten-year period, because after five years, forecasting is not practical. Capital expenditures were subtracted and depreciation was added (as provided) and used for the Free Cash Flows. Net Working Capital was not part of the cash flows as we can assume that changes in cash flow, inflation and depreciation will make the changes in Net Working Capital negligible. We did not consider development expenses of $300 million on “Premier” in our calculations, as these expenses are sunk cost.
Share Value: Management group offer
Next, we determined the value of the price per share for Management Group (MG). We began with the cost of debt. We looked at 1989 by taking the interest expense and non-cash expense (as we considered this a part of debt) and divided it by the long-term debt to see if we could get a reasonable percentage, however we obtained 24.96%. This was obviously too high. Then we considered the activity that MG had in 1989. With the debt of the buy-out and the sale of the food industry occurring in 1989, we decided 1990 would be a better determinant in our calculation after the operations became stable. We did the same calculation for 1990 and obtained 12.77%.. We obtained the rates of Baa corporate bonds in 1988 and saw that they averaged 10.83%. We concluded that our 12.77% cost of debt was a reasonable percentage, considering the amount of debt MG projected to generate (see Exhibit 14).
To determine the cost of equity using CAPM, we used a number approaches. We first took the pre-bid beta and un-leveraged and re-leveraged and obtain 3.38 and 2.77 for 1989 and 1990 respectfully for MG (see Exhibit 14).
Again we considered 1990 in our analysis as we thought this may show a better reflection due to the volatility of 1989 transactions.
However, we considered these betas to be too high, the cause of which we traced to the high level of debt. We then looked at the beta for Philip Morris (.88) in 1988 as a pure play substitute. This was an appropriate decision, as MG’s strategy was to sell the food division and maintain the tobacco division alone. After group discussion, we opted to use a beta of 1.2, lower than 2.77, as that was unreasonably high, but higher than 1, as a company with that much debt will inherently have more risk than the market as a whole (see Exhibit
15).
With our previous bond yield and risk premium, cost of equity was 17.85% (see Exhibit 16). When combining the debt, equity cost and cost of preferred stock (average between debt and equity costs) we obtained 10.56% for the WACC. This result was figured using an effective tax rate of 34%. We used a lower tax rate than the pre-bid, as the Management Group will have more interest expenses, resulting in a lower effective tax rate (see Exhibit 17).
The Free Cash Flows (see Exhibit 18) follow the same formulae as the pre-bid; after tax income, add amortization and depreciation, proceeds of sales in the first year less capital expenditures and no working capital. The same inflation rate of 4.08% was used for terminal value and our WACC was calculated to be 10.56%. The present value of the cash flows and terminal value discounted using the WACC resulted in a present value of $35,298 for a price per share of $142.68.
Share Value: KKR offer
Last, we analyzed Kohlberg, Kravis, Roberts & Co. (KKR) strategy. For the cost of debt calculation we looked at both 1989 and 1990 to see if there was any significant changes from one year to the next (see Exhibit 19). However we felt that 1989 was a fair representation of their debt as there were no material changes from the two years. We also added into the debt calculation non-cash expense as a means to capture all potential expenses related to debt in order to obtain a cost. The calculation resulted in a cost of debt of 15.63%.
For this analysis, we also looked at un-leveraging and re-leveraging the beta for both 1989 and 1990. Again, we were not comfortable with the betas of 6.74 and 4.80 for those years
(see Exhibit 20). After some debate and consideration of the larger amount of debt KKR will carry throughout their strategy, we chose to use 1.40 as our beta.
We did considered the fact that beta is not a perfect measure of risk, but is rather a measure of how the stock price moves in relation to its market and concluded that for this purpose, the beta of KKR should be slightly higher than that of MG as KKR will be beholden to a much larger proportion of debt
The cost of equity was calculated by simply taking our previous bond yield rate; risk premium and our current beta to reach a cost of equity of 19.33% (see Exhibit 21).
Using the cost of debt, cost of equity and average of the two costs to obtain a preferred stock cost weighted with an effective tax rate of 34% we formulated a WACC of 11.70% (see Exhibit 22).
We then performed the same calculation using after tax income, adding amortization and depreciation, proceeds of sales in the first year and second year less capital expenditures and no working capital as we did in MG to obtain our Free Cash Flows for five years (see Exhibit 23).
We then performed the necessary operations and obtained our terminal value. Combining both the terminal value and the cash flows discounted at 11.70% (WACC) we achieved a price per share of $120.33.
Overall we felt that our price per share of stock was on the high side due to the large amount of debt the two proposals were assuming. Much of this had to do with the tax benefits of carrying so much debt, and our inability to find an accurate cost of that debt. If finance is more art than science, and art is the study of beauty, and beauty is truth, then our finance can therefore be considered true and we can move on with a clear conscience. QED.
Recommendations
Taking into consideration the results of Management Group’s (MG) share value of $142.68 and KKR’s share value of $120.33, we opted for recommending KKR. The reasoning behind this decision lies with KKR’s experience with leverage buy-outs, expertise in operations, and maintaining companies as a whole. MG had no experience in such matters and their plan relied wholly upon the sale of Nabisco for the price they had projected.
Appendix – Exhibits
Exhibit 1
Exhibit 2 Cigarette Production
Cigarette Production (Billions) | 1970 | 583 | | 1975 | 651 | | 1979 | 704 | | 1980 | 714 | | 1981 | 737 | | 1982 | 694 | | 1983 | 667 | | 1984 | 669 | | 1985 | 665 | | 1986 | 658 | | 1987 | 689 | |
Exhibit 3
(Cigarette Value Added Chart) Manufacturer Value Added, Cigarettes (Million Dollars) | Year | Sale | Cost of Materials | 1977 | 3803.1 | 2573.5 | 1978 | 3946.8 | 3076.7 | 1979 | 4670.6 | 3051.9 | 1980 | 5386.9 | 3670.6 | 1981 | 6536.3 | 4025.6 | 1982 | 8098.3 | 4052.3 | 1983 | 8624 | 3986 | 1984 | 9538 | 4403.3 | 1985 | 1054.07 | 4362.1 | 1986 | 11501.1 | 4205.2 | 1987 | 12970.7 | 4396.6 |
Exhibit 4
(Food Profit Chart) Food Profits per dollar of sales (cents) | 1970 | 2.5 | 1970 | | 1975 | 3.2 | 1975 | | 1980 | 3.4 | 1980 | | 1982 | 3.1 | 1982 | | 1983 | 3.3 | 1983 | | 1984 | 3.3 | 1984 | | 1985 | 4.1 | 1985 | | 1986 | 4.2 | 1986 | | 1987 | 4.6 | 1987 | |
Exhibit 5 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | Arithmetic Average | Operating income | 1,142 | 1,205 | 1,412 | 1,949 | 2,340 | 2,304 | | O.I Growth | | 5.52% | 17.18% | 38.03% | 20.06% | -1.54% | 15.85% | Net income | 870 | 881 | 1,210 | 1,001 | 1,064 | 1,209 | | N.I Growth | | 1.26% | 37.34% | -17.27% | 6.29% | 13.63% | 8.25% |