A Note on Capital Cash Flow Valuation

Richard S. Ruback

Background Note | HBS Case Collection | November 1994 (Revised January 1995)

A Note on Capital Cash Flow Valuation

Abstract

Presents the capital cash flow method for valuing risky cash flows. In this method cash flows are calculated to include the benefits of interest tax shields. In a capital structure, with just ordinary debt and common equity, capital cash flows equal the flows available to equity--net income plus depreciation less capital expenditure and the change in working capital--plus the cash interest paid to bondholders. The interest tax shields decrease taxable income and thereby increase cash flows. Since the interest tax shields are included in the cash flows, a before-tax interest rate that corresponds to the riskiness of the assets is appropriate to value the capital cash flows.

Keywords: Capital; Cash Flow; Valuation;

Format: Print

13 pages

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Citation:

Ruback, Richard S. "A Note on Capital Cash Flow Valuation." Harvard Business School Background Note 295-069, November 1994. (Revised January 1995.)

The case describes the acquisition of Capitol Digital, which specialized in litigation support and digital forensics, including due diligence findings and first year operational plans.

Soon after Robin Kovitz (MBA 2007) acquired Baskits Inc., the largest gift basket company in Canada, she became convinced that the business needed to make significant operational improvements. In her first year as CEO, she introduced an ERP system to help with sales and purchasing and relocated the business to a more efficient facility. She wondered if she moved too quickly.

Case | HBS Case Collection | August 2019 (Revised October 2019)

Systems Design West

Richard Ruback and Royce Yudkoff

Jenn Braus (HBS 2013) was halfway through the 90-day exclusivity period for her proposed acquisition of Systems Design West (SDW). She had completed her business and accounting due diligence. Just as she was about to ask her lawyer to begin drafting the purchase agreement, she received a call from the seller that the company had reached agreement with a large new client that would increase revenue by roughly 20%. The seller asked that the success be reflected in an increased offer price, although he had not specified the amount of the increase.

Braus needed to decide on an appropriate response. Should she stand fast? In her mind, she had already agreed to pay a premium price for SDW, with a higher than typical multiple of EBITDA. Part of her rationale for the high multiple was that she believed the company had significant growth potential. Paying a higher price in response to the new customer seemed like paying twice for the growth. However, because the new customer was so large, Braus imagined that it would nudge the run rate EBITDA for SDW to about $1 million, eliminating a concern she had about the small size of the business. If she decided to negotiate a higher price, how much of an increase was appropriate? Simply applying historical margins would imply that a 20% increase in revenue would correspond to a 20% increase in price. Alternatively, it could be more as margins improved with operating leverage, or it could be less if significant fixed costs were required to on-board the new customer. Additionally, Braus was concerned that a new customer was inherently riskier than SDW’s typical customer that had a history of recurring revenue.

Keywords: Acquisition; Price; Negotiation Offer; Decision Making;

Citation:

Ruback, Richard, and Royce Yudkoff. "Systems Design West." Harvard Business School Case 220-004, August 2019. (Revised October 2019.) View Details

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A Note on Capital Cash Flow Valuation

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