Yours

Question 1:

The aim of this question is to define the price per share that would make buying the existing shares a zero NPV project. We are going focus our analysis on three plans: The pre-bid operating strategy, the management group’s operating strategy, the KKR’s operating strategy.

In order to reach this goal we first calculate the equity beta by calculating the return of unadjusted price per share and the return of the S&P 500. We use the S&P 500 as market price because RJR Nabisco isn’t set up in one unique market but in the tobacco and the food one. We have subtracted the risk free return to these previous returns in order not to take into account the general variation of the market.

We have chosen the 7-Year Treasury Constant Maturity Rate and not for 10 years one even if all the documents given in the case cover a 10 years period. In fact, there is no more debt at year 10 and we want a tax shield value different from 0. Taking the 7 years risk free rate is a way to avoid it.

Be = Cov rk, rfVar rf

We thus calculate the covariance between the return of Nabisco and the one of S&P 500, risk-free rate excluded; divided by the variance of the latter. We find an equity beta of 1,05.

RJR nabisco Equity beta | |

Cov | 0,00462418 |

Var | 0,00438874 |

Cov/ Var = Eq Beta | 1,05364633 |

In order to find the asset beta, we have assumed a debt beta equal to 0. We have also assumed that there is a maximum tax advantage to debt (34%).

Bu = EVl-DxTc x Be+ D x (1-T)Vl-DxTc x Bd =0,7396

E | 6038 | D(1-T) | 924,72 |

Vl-D*TC | 8601,44 | Vl - D x Tc | 8601,44 |

Be | 1,054 | Bd | 0 |

The asset beta describes how volatile the business is, irrespective of capital structure. You calculate asset beta by stripping out the capital structure impacts on the equity beta. The asset beta (also called unlevered beta) we have found is equal to 0,7396.

Once we have defined the equity beta βe and the asset beta βu, we can know evaluate the share...