RJR NABISCO CASE Name: John Paul Chua Questions for RJR Nabisco case 1.

What was the value of RJR Nabisco under Asset Beta:

= 0.50 = 0.92 Ba=(0.50+0.92)/2 = 0.7 Assume that Rf = 9% (from the Marriott Case) Assume that Rp=8% (from the Marriott Case) Ka = Rf + BARp Ka = 9% + (0.7)(8%) = 14.6% a) The pre-bid operating strategy?

b) The Management Group's strategy?

c) KKR's operating strategy?

2. What accounts for any difference in the value of three operating plans? The difference in value of all 3 operating plans stems from the difference in operating strategies by the 2 bidders. This resulted in different capital cash flow forecasts which resulted in the different valuation. The management groups proposed strategy was to sell part of RJR Nabiscos food businesses since they believed that the business was undervalued by market. They believe that separating could help the market distinguish the tobacco business and food business and realize the true intrinsic value of each business. They believe that doing this would help market realize the companys value more efficiently and maximize shareholdersinterests. It is also part of a leveraged buyout, part of which is financed by long term debt, altering the capital structure going forwards. More debt leads to a greater valuation of the firm due to the higher tax shields. KKR on the other hand wanted to maintain all of the tobacco business and food operations. KKR want to expand the tobacco to Winston-Salem, North Carolina. KKR believes continuing operating food business properly could bring more benefit than simply sell the assets of food business and recognize gain at one time and since it involved more debt, it will also result in a new capital structure thus increasing its valuation. The three operating plans account for different amounts of assets due to varying operating strategies as well as various amounts of long-term debt. This reflects the idea that operating decisions are the main motivation behind the value of RJR Nabisco. 3. Evaluate the Special Committee's use of an auction of RJR Nabisco? The Special Committees decision to use a sealed auction for the sale of RJR Nabisco would allow potential buyers to compete with one another to propose their best bids to maximize shareholder value and prevent collusion. It fulfills Nabiscos fiduciary duty to the shareholders. Accepting bids from all over will allow competition to drive the price to the highest possible level and will also accept bids from all any willing participants instead of a select few. By putting in place anti hostile take over measures, it helps prevents any potential hostile takeovers thus protecting the sharholders which is also in the best interest of the shareholders. Secondly, the Special Committees rules of the auction will prompt a swift acquisition. KKR and Management Group have been considering a joint bid since 1987; after one year, no deal has been finalized. By participating in an auction, companies must submit their proposals by a deadline to enter each round of bidding. This allows the deal to conclude quickly as compared to if private negogiations with each individual parties where to be held. Furthermore, the use of an auction which requires each bidder to submit proposals, would allow the board to evaluate the merits of each bid in the best interest of its shareholders. This is especially attractive since the payment is mostly made in cash, and shareholders will want to receive their share as quickly as possible. However, a public auction often leads to a bidding frenzy resulting in overvaluation

of the company which may be detrimental in the long run as they pile more debt onto RJR Nabiscos balance sheet when they acquire the firm. 4. Which bid should the special committee select, if any? What other actions should the special committee take? From the companys point of view, both Management and KKRs bids result in increased cash flows from the existing operating structure as a result of tax shields from debt and change in operations. Therefore, both plans will enhance the companys performance in the foreseeable future, though KKRs plan does result in slightly higher cash flows. Under KKRs offer at $92 per share, Nabiscos operating structure would stay intact, maintaining the image of the company as well as continuing to offer job security for its existing employees. However, the Special Committees fiduciary responsibility is not fulfilled if they do not act in the shareholders best interest. Management Groups bid is $8 higher per share than KKRs, with less pay-in-kind preferred stock and more cash as payment. The Special Committee should choose Managements bid of $100 per share in order to best fulfill its duties to the shareholders and also promise cash flows for the company in the upcoming years which are comparable to the KKR bid.