Phillip Morris offers to purchase all Kraft common stock at $90 per share in cash. This represents a 50% premium over the previous day’s close of $60.125 per Kraft share. Kraft announces a recapitalization plan which it values at $110 per share, $84 in cash, $14 in high yield debt (“cram-down debt”), and the remaining in highly levered equity valued at $12 per share (the “stub”). Assume that the risk free rate is 8.5% and the expected market risk premium is 7.5%. Both cash and non-cash interest expense is deductible for tax purposes.Assume that the expected return of Kraft’s equity is 14.1%.
1)Based on the forecast provided in Exhibit 12 and the methodology discussed in this course, can you justify the $110/share valuation? The $12/share valuation of the “stub”? For the purpose of this part, assume that the assumptions underlying exhibit 12 are correct. Present a DCF valuation of the restructured firm based on the assumptions underlying Exhibit 12 forecasts. Hint: are the forecasted cash flows of exhibit 12 the type of cash flows that you need for valuationpurposes?
2)Are these forecasts (the firm’s forecasts) reasonable? Provide an evaluation/critique of the main assumptions.
3)Make your own forecast, which you believe is reasonable. What is the value to shareholders of the restructuring proposed by Kraft based on your assumptions? Please state your main assumptions and value Kraft accordingly.
