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Advanced Corporations. Prof. Diamond SCU School of Law Week Three Class Two (2007). Valuation. Cash flow methods If Balance Sheet and Income Statement approaches are problematic Can we value company using actual cash flow Two dominant methods DDM DCF. Valuation. DDM

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Presentation Transcript

Prof. Diamond

SCU School of Law

Week Three Class Two (2007)

• Cash flow methods

• If Balance Sheet and Income Statement approaches are problematic

• Can we value company using actual cash flow

• Two dominant methods

• DDM

• DCF

• DDM

• Requires three steps

• Predict dividends: hard since it depends on board

• Choose discount rate

• Consider potential for growth

Formula is same as a perpetuity:

V = D/K, where V = Value; D = Dividend and K = discount rate

• DCF

• Dominant valuation method today

• Relies on internal cash flows so independent of corporate politics

• Some companies keep earnings to grow so this allows you to value them

• Value obtained in capital gains

• Formula similar to DDM with some tweaks

• Capital Budgeting

• This is the transfer of our fundamental decision rule into management of company

• Determine cash flows and cost of capital to see if project has Positive NPV

• Use an “R” that is opportunity cost of capital

• A slight variant is IRR - the discount rate that will cause a project’s PV of cash inflows to equal cash outflows (NPV = 0).

• Where IRR is higher than OCC then choose IRR. (NPV will be > 0)

• Valuation in a close corporation

• Impact of “Perqs”

• Clubs

• Apartments

• Jet

• Salaries

• Mike’s view?

• Courts jump into valuation in three contexts:

• Appraisal proceeding

• Shareholder remedy in merger

• Conflict among shareholders

• Other contexts

• Liquidation

• Divorce

• Tax proceedings

• Delaware Block Method

• Weighted average of different models

• Makes some sense given limits of valuation models

• Piemonte

• Does this kind of analysis make us feel more comfortable?

• Holmes: Law is our ability to predict what judge will do.

• Weinberger: What happened to the Delaware block method?

• Important case in M&A law that we will revisit

• Here it gave Delaware courts chance to modernize valuation approach

• Duty of parent to minority s/h in merger

• Fashioned “entire fairness” test including “fair price”

• Weinberger

• Block method “clearly outmoded”

• Duty to determine fair value, including all relevant factors, other than impact of merger itself

• Emphasis on “future value” leading to DCF approach

• Block method still around - Leader (MA)

• Smith Drugstores Part III (p. 175)

• “Minority Discount”

• “Marketability Discount”

• Should these ideas impact the valuation discussion?

• Cavalier Oil

• Appraisal action on behalf of Harnett

• EPIC Mortgage Servicing

• Sole minority shareholder in a closely held company

• Concise statement of appraisal remedy

• Is there a “minority discount”?

• What does Harnett deserve to get?

• Cavalier Oil

• No minority discount

• He deserves to get what was taken away:

• A share in a going concern

• How do we do that?

• Value Company as a whole first

• That awards Harnett the “control premium”

• Pueblo (Col. 2003)

• Cash out of minority shareholders

• Holding Corp. offered only \$341 per share but agreed that firm was worth at least \$73 mn, or \$638 per share

• Why the discrepancy?

• What did trial court do and what is issue on appeal?

• Pueblo

• Same standard as Delaware: Fair value

• Three different interpretations

• Corporation as a whole

• Case by case

• What are the implications of each?

• Pueblo

• Case by case?

• Leaves litigants in dark

• Means applying minority and marketability discounts

• Corporation as an entity?

• No discount at shareholder level

• Conclusion?

• Pueblo

• Case by case is untenable

• “FV” (statutory language)  FMV

• Not a willing seller!

• Unwilling with little or no bargaining power

• What is the goal of appraisal?

• Protection against oppression of minority shareholders

• So what?

• Pueblo

• Ex ante deterrence of oppressive majority behavior; ex post compensation

• Here, goal of merger was to force out certain shareholders (C Corp to S Corp)

• Deserve to be compensated for what they lost

• Discounts would undervalue shares

• Consistent with national policy - Delaware, MBCA and ALI

• What is the difference between a “marketability discount” and a “minority discount”?