Lessons in Corporate Finance, 2nd Edition

CHAPTER 20Valuing an Acquisition: Free Cash Flows to the Firm (The Dollar Stores)

In the previous chapter, we examined the strategic fit between Family Dollar and Dollar General or Dollar Tree. In this chapter, we will estimate the value of Family Dollar.

We introduced valuation in Chapters 15 and 16, using the Sungreen case. Chapter 17 extended the discussion on valuation by looking at a number of nuances. This chapter will do another valuation in more depth to help readers better understand the formulas, as opposed to merely memorizing them. As we did with Sungreen, we start with the free-cash-flows-to-the-firm (FCF_f) technique. Then in the next chapter we will introduce the free-cash-flow-to-equity (FCF_e) technique and compare it to the free-cash-flows-to-the-firm technique.

We begin with Dollar Tree's bid for Family Dollar. To obtain the pro formas used to generate the cash flows and to estimate the cost of capital for Family Dollar, we will rely upon Family Dollar's proxy statement, which includes the estimates done by Morgan Stanley (Family Dollar's investment banker). Where necessary, we will reverse engineer the valuation elements not explicitly provided in the proxy statement. We will then calculate the terminal value using the multiple and perpetuity approaches. We then put the three pieces of a valuation together (i.e., the purchase price, the discounted cash flows, and the terminal value) to value Family Dollar.

Note, the pro formas for Family Dollar were done prior ...