Market reaction
a. On the day MidAmerican Energy Holdings announced its
acquisition of PacifiCorp from Scottish Power plc, the market reacted
in the following way:
- Berkshire Hathaways A share price increased by 2.4%
- Scottish Powers share price rose by 6.28%
- S&P 500 Composite Index value accrued by 0.02%
According to the above numbers, it would be correct to say the
stock market has been positively reacting to the acquisition. It could
be interpreted as a good indicator that the deal has been worthwhile
for both the acquirer and the seller. The positive reaction from stock
market also reveals that the deal has created value for both
protagonists.
b. According to the increasing per-share changes in both
companies, it would be correct to assume that value has been
created from this deal. By closing up by 2.4%, Berkshire Hathaway
increased its market value by $2.55 billion. This instant increase in
share price could be interpreted as an expected benefit from this
acquisition, and ultimately, could reveal that Berkshire Hathaway
paid the acquisition at a discount price per share.
Similarly, Scottish Powers increase by 6.28% represents an
increase of GBP27.75 in per-share change. Because the amount of
share outstanding for Scottish Power is 466,120,000, the increase in
market value that day was $12.93 billion British pounds.
Bid assessment
4.
2002
$m
253.2 -3064.4
2003
$m
2004
$m
1290.2
1326.4
Step 1:
Firstly, apply dividend discount model to access the present value of the four year
accruing cash flows. As the MidAmerican will has a constant growth rate perpetuity
t
CF t
start from 2004. It would be assessed by discount model: PV=
. Based
t
t =1 ( 1+ r )
on the accruing FCF and the CAPM rate 9%, the PV of the four years FCF is sum up
to $-423.9m. Secondly, taking account of the constant growth rate from 2004, apply
CF 2004 (1+ g)
the formula TV = (rg) ' to work out the terminal value in 2004 and then
discount it back to 2000, which equals to $11022.2m. The aggregated present value of
the investment is $10598.3m.
Step 2:
Compare the value of the investment with initial investment cost of Berkshire
Hathaway in 2000. Remember to aggregate the present value of investment cost of
$402m with the cost of $1240m to figure out the total cost of the investment
$1578.4m in 2000. By doing this, the NPV is resulted at $9019.9m with an initial rate
of return 67%.
Based on the quantitative analysis above, although MidAmerican generated some
negative cash flow in some year due to business expansion, it still create value for
5
is the market value of the Big four in 2004 and the beginning value is the investment
cost in 1992. By input the values and 12.5 years, and the CAGR for the 12.5 years
investment would be 16.07%. It represents a smoothed annualized investment gain of
16.07% for Berkshire over the 12.5 years period.
Another method would be using NPV method to work out the net gain of the
investment by comparing the present market value of the Big Four in 1992 with the
total investment cost in Big Four within the same period. Firstly, simply discount the
market value of Big Four in 2004 back to 1992 with 9% discount rate. Because the
investment is made by Berkshire, the discount rate used to evaluate the market value
of the Big Four should be the cost of equity of Berkshire. The discounted market
value of Big Four is up to $8405m in 1992. Comparing $8405m market value with
$3832m initial investment in 1992, the difference $4573m would be the net gain for
Berkshire. According the NPV rules, positive $4573m is an optimistic desirable gain.
Also the market value to cost ratio in 2000 is $2.19. It reveals that every $1 Berkshire
Hathaway invests in the Big Four, can earn $2.19 in return. It is a good investment
for Berkshire to generate over twice in return. Further, since 1992, the Big Four
shows a positive increasing pattern in the stock market which market price of the
shares increasing significant amounts.
7.
Investment philosophy
Warren Buffetts investment philosophy is derived from Prof. Benjamin Graham
method of identifying undervalued stocks, which he supplemented the notion of
recognising undervalued franchise from the market. He abides by 7 principles that he
defines as being essential in performing an efficient investment. Buffetts principles
are actually simple, easy to be understood and followed. In common, his
character is conventional as he sees prospects of an investment in
the long-term prospective and his success is a combination of
careful calculation, courage and patience. The following section
assesses Buffetts investment philosophy:.
1. Economic reality, not accounting reality
According to Buffett, accounting principles are backwardlooking and abide by generally accepted accounting principles
(GAAP). As a matter of fact, he distinguishes economic reality and
6
Spend wisely
Overcome your fear of risk
Focus on the long term
Invest in quality business
Sell losing stocks when the market is up, buy winning stocks
during a crash
Make decisions to invest based on how well money is being
used by company management
CONCLUSION
Reference list
Anh,T (2014), Lecture note stock valuation. [Online]. Available at:
http://moodle.city.ac.uk/mod/resource/view.php?id=258565 .
Anh, T (2014). Lecture note Investment decision rules. [Online]. Available at:
http://moodle.city.ac.uk/mod/resource/view.php?id=258582 .
FSIC (Federal Deposit Insurance Corporation)(2014). RMS Manual of Examination
polices Other assets and liability (3/12) section 3.7. [Online]. Available at:
https://www.fdic.gov/regulations/safety/manual/section3-7.pdf.
10
Median
7,000
Mean
6,000
Bid
5,000
4,000
3,000
2,000
1,000
0
#REF!
#REF!
#REF!
3,000
2,000
1,000
0
11
Question 5
(All in million $)
EBT
Other interest expense
Interest expense
debt held by Berkshire
EBIT
Tax (40%)
EBI
Depreciation
2000
5349
2659
3154
-495
2001
419
443
2002
523
640
2003
727
716
2004
816
713
50
118
184
170
912
364.8
547.2
539
1086.
2
6537
1188
2450
3300
-850
-355
1281
512.4
768.6
530
1627
650.8
976.2
603
1699
679.6
1019.4
638
1298.6
1579.2
1657.4
10285
3748
3892
4127
-235
615
3064.4
83.70
%
2564.9
11181
896
3658
4500
-842
-607
11607
426
3990
4927
-937
-95
1290.2
1326.4
80.50
%
80.50
%
1038.6
1067.8
2003
2004
1038.6
1067.8
802.0
756.4
253.2
76%
192.4
9%
2%
Step 1
2001
192.4
Discounted CF
176.5
PV of first 4 years CF
-423.9
1352.9
1089.1
15558.
7
11022.
2
PV in 2000
Total PV of FFCF
2002
2564.9
2158.8
10598.
3
12
2000
1240
1578.4
10598.
3
9019.9
67%
Total PV of FFCF
NPV
IRR
2002
402
IRR calculation
cash flow
2000
-1578.4
2001
192.4
2002
-2564.9
2003
1038.6
2004
16626.4
IRR
67%
Question 6
company (Big
Four)
American
Express
Coca-Cola
Gillette
Wells Fargo
shares
%of CO.
owned
151,610,7
00
200,000,0
00
96,000,00
0
56,448,38
0
Cost
($mm)
12.1
1470
8546
17%
8.3
1299
8328
16%
9.7
600
4299
14%
3.3
463
3508
13%
3832
24681
Market($m Cost/
m)
Market
12.5
9%
$24681mm
$3832mm
16.07%
9%
13
$24681mm
12.5
$8405mm
$4573mm
$2.19
14