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Corporate Finance
Santa Clara University School of Law
Diamond, Stephen F.

Course: Corporate Finance
Professor: Stephen F. Diamond
Semester: Spring 2012


Valuation
Theories of Valuation
·         Foundation Theory: Common Stock valuation based on projected dividend stream
·         Castles in the Air: Common Stock valuation based on willing of others to pay in future
Valuation Formulae
·         Present Value . . . . . . . . . . PV = p(1+r)t or p(1+r/m)mt
·         Future Value . . . . . . . . . . . FV = PV/(1+r)t
·         PV Ordinary Annuity . . . . . . .  PVa = ∑(xt/(1+r)t)
·         Effective Annual Interest Rate . . EAIR = (1+r)t – 1
·         PV Annuity Due . . . . . . . . . . PVad = ∑(xt/(1+r)t-1)
Methods of Valuation (corporation as central asset)
·         Balance Sheet Methods
o    Book Value = Total Assets – Total Liabilities
o    Book Value per Share = BV/# of shares
o    Adjusted Book Value: attempts to value assets according to appreciation, rather than historical cost
o    Net Asset Value: valuates corporation as a “going concern”
§  BV + Goodwill
§  Market-to-Book Ratio: M/(BV/shares)
·         Usually greater than 1
·         Avg. 2-2.5
o    LIMITATIONS: BS methods valuate for purposes of liquidation
·         Income Statement Method(s)
o    Capitalization of Earnings . . . Ve = E/R
(Where E = Earnings, and R = cap rate)
§  NOTE: Cap. rate reflects risk
[i.e. low (≤12.5%), med. (15-25%), high (≥30%)] §  Deciphering E: use normalized earnings (avg. of past 5 yrs.)
§  Deciphering R: use Price/Earnings Ratio of like company
§  R = 1/(P/E) = E/P


Methods of Valuation (cont’d)
·         Cash Flow Statement Methods
o    Dividend Discount Method (DDM)
(NOTE: assumed investor intends to hold long-term)
§  Zero-Growth Dividend . . . . V = D/r
(where D = constant dividend, r = discount rate)
·         If V0 is known, then r can be determined by r = D/V0
§  Constant-Growth Dividend . . V = D1/(r-g)
(where D1 = Dividend at Yr 1, r = discount rate, g = growth rate)
·         If V is known, then r can be determined by r = g+(D1/V)
o    Discount Cash Flow (DCF)
§  V = PVCashFlow + PVHorizon
(PVCashFlow = C1/(1+r)1 + C2/(1+r)2; PVHorizon = C2/(1+r)2)
§  Use P/E Ratio to determine r


Valuation in Appraisal Proceedings
·         Basic Concept: stockholder is entitled to be paid for his proportionate interest in a going concern (meaning future prospects must be considered)
(Weinberger,157)
·         Del. Block Method: Market Val (10%); Earnings Val (40%), Net Asset Val (50%)
o    Rejected in Weinberger: proof of value by any technique/method accepted in financial community & admissible in court
·         Merger price must include evidence showing it represents value of going concern rather than value of company to one specific buyer
·         Del. G.C. Law § 262: discretion to award simple or compound interest
o    Simple: $100+($100)(.08)(7yrs)
o    Compound: $100(1+.08)7
·         Minority & Marketability Discounts
o    Objective of § 262 is to value the corporation itself, not shares
(THINK: no discount) (Cavalier Oil,177)
o    Minority discount fails to appraise as going concern
o    Fair Value: value o

, not restriction
(Biltmore Tissue,205)
o    Good faith and loyalty issues do not arise when shareholders agree in advance for purchase of stock of withdrawing/deceased shareholder
(Evangelista,206)
·         EXCEPTION: Fiduciary duty requires disclosure of intent to frustrate purpose of agreement in closely held corp.; failure to disclose invalidates agreement
(THINK: survivor purchase price adjustment provision requiring assent of both parties and one party intends to never assent to adjustment)
(Duckworth,209)
·         EXCEPTION: Forced buy-out may permit circumvention of agreement where court determines agreement only applies to voluntary sales
(Pace Photographers,211)


Other Valuation Scenarios
·         Dissolution & Goodwill: good will belongs to the corp., not individual shareholders, and can be determined by subtracting tangible assets from capitalization of earnings
o    NOTE: Salary payment above normalized salary should in added back into earnings
(Donahue v. Draper,214)
·         Divorce Proceeding (Nardini,217)
o    Value cannot be less than liquidation value
o    Distribution Alternatives
1)  Division of asset(s)
2)  Liquidation and division of proceeds
3)  Allocation to one, with proportional compensation to other