RJR Nabisco

Some genius invented the Oreo. Were just living

off of the inheritance.
F. Ross Johnson

Fair Market Value

Fair Market Value: the price at which the
asset would trade between two rational
individuals, each in command of all of the
information necessary to value the asset, and
neither under any pressure to trade.
Rocky Higgins
Analysis for Financial
Management (p. 318)

Capital Budgeting 101

Step 1: Estimate Discount Rate
Step 2: Project Cash Flows
Cash flows for 1989-98 in tables
Terminal value

Step 3: Compute Net Present Value (NPV)

Accept positive NPV projects

Discount Rate
As we discussed, the discount rate is the weighted
average cost of capital (WACC).
D
E
WACC
E (rd )(1 t )
E (re )
DE
DE

where t = tax rate,

E(rd) = expected cost of debt
D = amount of debt in capitalization
E(re) = expected cost of equity
E = amount of equity capitalization

Discount Rate
To calculate the WACC using 1989 figures under the three
strategies:
5,204
12,790
Prebid :
(.09)(1 .34)
(.168) .137
5,204 12,790
5,204 12,790
11,186
4,202
Mgmt :
(. 098 )(1 .34 )
(.250 ) .115
11,186 4,202
11,186 4,202
18,932
4115
KKR :
(. 102 )(1 .34 )
(. 330 ) .114
18,932 4115
18,932 4115
NOTE: since the capital structure changes over time, we need to
recompute the WACC each year to reflect the change in capital
structure.

Projected Cash Flows

Projected cash flows for 1989 are calculated as follows:
Rev.
- Exp.
- Depr.
TI
- Tax
Net Inc.

Prebid Mgmt
18,088
7,650
14,429
5,544
807
777
2,852
1,329

KKR
16,190
12,596
1,159
2,435

970
1,882

452
877

828
1,607

807

777

1,159

- Cap.Exp.

1,708

432

774

- Chg WC

80

41

79

0
901

12,680
13,861

3,500
5,413

+ Depr.

+ Asset

Sale
Net CF

Projected Cash Flow

The following cash flow represent the cash flow computed
from the tables:
Year
1989
1990
1991
1992

Prebid Management KKR

901
13,861 5413
1385
1486 4909
1856
1768 2526
2528
2062 2745

1993
1994
1995

2985
3261
3555

2278
2507
2755

2855
3101
3364

1996

3887

3029

3651

1997

4246

3332

3970

1998

4575

3666

4319

Terminal Value
To estimate a terminal value, we need to make an
assumption about future growth after 1998.
If cash flows grow by 2.5% per year (and the WACC
remains constant), then for the pre-bid strategy:
4575(1 .025)
PV (1998)
38,755
.146 .025
For the Management Group scenario:
3666 (1 .025 )
PV (1998 )
31,055
.146 .025

For the KKR scenario:

4319 (1 .025 )
PV (1998 )
36,587
.146 .025

Terminal Value
Results will depend on the growth rate assumption.
Values in 1998 of cash flows for 1999 and beyond for
different assumptions are (Sensitivity Analysis):
Growth Rate
Strategy
Pre-Bid

0%
31,336

2.5%
38,755

5%
50,039

Management

25,110

31,055

40,097

KKR

29,582

36,587

47,239

Present Value
The present value of the cash flows for the prebid strategy
is (using the 2.5% growth rate assumption after 1998): ($
millions)
901
1385
1856
PV

2
3
1.137 (1 .139)
(1 .14)

...

4575 38,755
22,607
10
(1 .146)

This represents the total value of RJR Nabisco (ASSETS).

Present Value
To figure out the value per share of RJR Nabisco to the
CURRENT shareholders, consider the pre-bid valuation:
Total Assets = 22,607
Current Debt = 5,204
Equity = 17,403

17,403
PerShare
70.34
247 .4

Valuation
Estimates of the value per share under the alternatives
(again, using the 2.5% growth rate assumption):
Strategy

Total

Debt

Equity

Share Price

Prebid
Management

22,607
30,593

5204
5204

17,403
25,389

$70.34
$102.62

KKR

29,278

5204

24,074

$97.31

Sources of Value
The company is worth substantially more under either the
KKR or the Management Group plan.
There are smaller differences between the KKR value and
the management value.
The buyout plans propose to

increase debt
trim excesses
decrease capital expenditures
sell food assets
decrease operating profits

All gains are based on projections.

What Happened?
Per share bids:

MGMT
KKR
FB

Case (11/18)
$100
94
98-110

11/29/88
$101
106
103-115

Activities of Special Committee

Concluded that First Boston bid was impractical.
Began to negotiate terms with KKR.
Letter from Management Group protesting
negotiations with KKR, offering to negotiate all
aspects of its proposal.
Special Committee decided to consider new bids.

Activities of Special Committee

Summary of final bids (substantially equivalent):
Bid
Valuation
MGMT
$112
$108
KKR
109
108
Chose KKR:

more equity (25% vs 15% for mgmt)

retain more businesses
fewer PIK securities
more benefits to terminated employees.

Summary: RJR Nabisco

Fundamentals of firm valuation: discounted cash
flow techniques.
Relation between managerial decisions and firm
cash flows.
Operating decisions can create or destroy value.

Role of a corporate governance system that

encourages value-enhancing decisions.