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| Case Study 40 - Chrysler Corporation: Negotiations Between Daimler and Chrysler |
| Additional Resources for Chrysler Case Study Solution Spreadsheets for Solutions |
| Solution for Case Study #40 - Chrysler Corporation: Negotiations Between Daimler and Chrysler Negotiating a complex cross-border merger |
How to Solve Case
Outline of Topics needing to be discussed
1. Chrysler Products
Lack of mid-size vehicles, focused on trucks and SUVs. Did not
take into account energy efficient auto evolution.
2. Chrysler Product Development and Manufacturing Strategy
Had a lack of product diversification. Focus was too heavily on
competing in the "Big 3" and not with the Asian competitors. This
would later prove faulty.
3. Chrysler International Strategy
Focused on Latin America. Not effective in Europe, lack of
presence in Asia.
4. Daimler-Benz AG
5. Daimler-Benz Diversification Under Reuter
6. Jurgen Schrempp
7. Daimler-Benz Restructuring Under Schrempp
8. Daimler-Benz Aerospace Segment
9. Daimler-Benz Commercial Vehicle Segment
10. Passenger Car Segment
11. Car Segment Growth and Strategy Models
12. Car Segment Design and Production
13. Car Segment International Strategy
14. Ownership
15. Labor Unions
16. Executive Compensation
17. Trends
18. Strategy Alternatives
19. History of the Merger
20. Valuation and EPS Analysis
The Discounted Cash Flow method is the choosen valuation
method provided in the spreadsheets.
[Discounted Cash Flow definition - the discounted cash flow (or
DCF) approach describes a method to value a project or an entire
company using the concepts of the time value of money. All future
cash flows are estimated and discounted to give them a present
value. The discount rate used is generally the appropriate cost of
capital, and incorporates judgments of the uncertainty (riskiness)
of the future cash flows.]
There are 2 methods used for calculating the Terminal Value.
[The terminal value of a security is the present value at a future
point in time of all future cash flows when we expect stable growth
rate forever. It is most often used in multi-stage discounted cash
flow analysis, and allows for the limitation of cash flow projections
to a several-year period. Forecasting results beyond such a period
is impractical and exposes such projections to a variety of risks
limiting their validity, primarily the great uncertainty involved in
predicting industry and macroeconomic conditions beyond a few
years. Thus, the terminal value allows for the inclusion of the value
of future cash flows occurring beyond a several-year projection
period while satisfactorily mitigating many of the problems of
valuing such cash flows. The Terminal Value is calculated in
accordance with a stream of projected future free cash flows in
discounted cash flow analysis. For whole-company valuation
purposes, there are two methodologies used to calculate the
Terminal Value.]
Outline of Topics needing to be discussed
1. Chrysler Products
Lack of mid-size vehicles, focused on trucks and SUVs. Did not
take into account energy efficient auto evolution.
2. Chrysler Product Development and Manufacturing Strategy
Had a lack of product diversification. Focus was too heavily on
competing in the "Big 3" and not with the Asian competitors. This
would later prove faulty.
3. Chrysler International Strategy
Focused on Latin America. Not effective in Europe, lack of
presence in Asia.
4. Daimler-Benz AG
5. Daimler-Benz Diversification Under Reuter
6. Jurgen Schrempp
7. Daimler-Benz Restructuring Under Schrempp
8. Daimler-Benz Aerospace Segment
9. Daimler-Benz Commercial Vehicle Segment
10. Passenger Car Segment
11. Car Segment Growth and Strategy Models
12. Car Segment Design and Production
13. Car Segment International Strategy
14. Ownership
15. Labor Unions
16. Executive Compensation
17. Trends
18. Strategy Alternatives
19. History of the Merger
20. Valuation and EPS Analysis
The Discounted Cash Flow method is the choosen valuation
method provided in the spreadsheets.
[Discounted Cash Flow definition - the discounted cash flow (or
DCF) approach describes a method to value a project or an entire
company using the concepts of the time value of money. All future
cash flows are estimated and discounted to give them a present
value. The discount rate used is generally the appropriate cost of
capital, and incorporates judgments of the uncertainty (riskiness)
of the future cash flows.]
There are 2 methods used for calculating the Terminal Value.
[The terminal value of a security is the present value at a future
point in time of all future cash flows when we expect stable growth
rate forever. It is most often used in multi-stage discounted cash
flow analysis, and allows for the limitation of cash flow projections
to a several-year period. Forecasting results beyond such a period
is impractical and exposes such projections to a variety of risks
limiting their validity, primarily the great uncertainty involved in
predicting industry and macroeconomic conditions beyond a few
years. Thus, the terminal value allows for the inclusion of the value
of future cash flows occurring beyond a several-year projection
period while satisfactorily mitigating many of the problems of
valuing such cash flows. The Terminal Value is calculated in
accordance with a stream of projected future free cash flows in
discounted cash flow analysis. For whole-company valuation
purposes, there are two methodologies used to calculate the
Terminal Value.]
More on Terminal Values
Perpetuity Growth Model (this method should be used for the CHRYSLER Case Study analysis)
The Perpetuity Growth Model accounts for the value of free cash flows that continue into perpetuity in the future, growing at an
assumed constant rate. Here, the projected free cash flow in the first year beyond the projection horizon (N+1) is used. This value is
divided by the discount rate minus the assumed perpetuity growth rate: T(0) = FCF N+1 / (k - g). T(0) is the value of future cash flows
at a future point in time which is immediately prior to N+1, or at the end of period N, which is the final year in the projection period.
This equation is a perpetuity, which uses a geometric series to determine the value of a series of growing future cash flows.
To determine the present value of the terminal value, one must discount the Terminal Value at T(0) by a factor equal to the number of
years included in the initial projection period. If N is the 5th and final year in this period, then the Terminal Value is divided by (1 + k)^5.
The Present Value of the Terminal Value is then added to the PV of the free cash flows in the projection period to arrive at an implied
Enterprise Value.
Exit Multiple Approach
The Exit or Terminal Multiple Approach assumes a business will be sold at the end of the projection period. Valuation analytics are
determined for various operating statistics using comparable acquisitions. A frequently used terminal multiple is Enterprise Value /
EBITDA. The analysis of comparable acquisitions will indicate an appropriate range of multiples to use. The multiple is then applied
to the projected EBITDA in Year N, which is the final year in the projection period. This provides a future value at the end of Year N.
The terminal value is then discounted using a factor equal to the number of years in the projection period. If N is the 5th and final year
in this period, then the Terminal Value is divided by (1 + k)^5. The Present Value of the Terminal Value is then added to the PV of the
free cash flows in the projection period to arrive at an implied Enterprise Value. Note that if publicly-traded comparable company
multiples must be used, the resulting implied enterprise value will not reflect a control premium. Depending on the purposes of the
valuation, this may not provide an appropriate reference range.
Comparison of Methodologies
There are several important differences between the two approaches.
The Perpetuity Growth Model has several inherent characteristics that make it intellectually challenging. Because both the discount
rate and growth rate are assumptions, inaccuracies in one or both inputs can provide an improper value. The difference between the
two values in the denominator determines the terminal value, and even with appropriate values for both, the denominator may result
in a multiplying effect that does not estimate an accurate terminal value. Also, the perpetuity growth rate assumes that free cash flow
will continue to grow at a constant rate into perpetuity. Consider that a perpetuity growth rate exceeding the annualized growth of the
S&P 500 and/or the U.S. GDP implies that the company's cash flow will outpace and eventually absorb these rather large values.
Perhaps the greatest disadvantage to the Perpetuity Growth Model is that it lacks the market-driven analytics employed in the Exit
Multiple Approach. Such analytics result in a terminal value based on operating statistics present in a proven market for similar
transactions. This provides a certain level of confidence that the valuation accurately depicts how the market would value the
company in reality.
On the other hand the Exit Multiple approach must be used carefully, because multiples change over time. Simply applying the current
market multiple ignores the possibility that current multiples may be high or low by historical standards. In addition, it is important to
note that at a given discount rate, any exit multiple implies a terminal growth rate and conversely any terminal growth rate implies an
exit multiple. When using the Exit Multiple approach it is often helpful to calculate the implied terminal growth rate, because a multiple
that may appear reasonable at first glance can actually imply a terminal growth rate that is unrealistic.
In practice, academics tend to use the Perpetuity Growth Model, while investment bankers favor the Exit Multiple approach. Ultimately,
these methods are two different ways of saying the same thing. For both terminal value approaches, it is essential to use a range of
appropriate discount rates, exit multiples and perpetuity growth rates in order to establish a functional valuation range.
Perpetuity Growth Model (this method should be used for the CHRYSLER Case Study analysis)
The Perpetuity Growth Model accounts for the value of free cash flows that continue into perpetuity in the future, growing at an
assumed constant rate. Here, the projected free cash flow in the first year beyond the projection horizon (N+1) is used. This value is
divided by the discount rate minus the assumed perpetuity growth rate: T(0) = FCF N+1 / (k - g). T(0) is the value of future cash flows
at a future point in time which is immediately prior to N+1, or at the end of period N, which is the final year in the projection period.
This equation is a perpetuity, which uses a geometric series to determine the value of a series of growing future cash flows.
To determine the present value of the terminal value, one must discount the Terminal Value at T(0) by a factor equal to the number of
years included in the initial projection period. If N is the 5th and final year in this period, then the Terminal Value is divided by (1 + k)^5.
The Present Value of the Terminal Value is then added to the PV of the free cash flows in the projection period to arrive at an implied
Enterprise Value.
Exit Multiple Approach
The Exit or Terminal Multiple Approach assumes a business will be sold at the end of the projection period. Valuation analytics are
determined for various operating statistics using comparable acquisitions. A frequently used terminal multiple is Enterprise Value /
EBITDA. The analysis of comparable acquisitions will indicate an appropriate range of multiples to use. The multiple is then applied
to the projected EBITDA in Year N, which is the final year in the projection period. This provides a future value at the end of Year N.
The terminal value is then discounted using a factor equal to the number of years in the projection period. If N is the 5th and final year
in this period, then the Terminal Value is divided by (1 + k)^5. The Present Value of the Terminal Value is then added to the PV of the
free cash flows in the projection period to arrive at an implied Enterprise Value. Note that if publicly-traded comparable company
multiples must be used, the resulting implied enterprise value will not reflect a control premium. Depending on the purposes of the
valuation, this may not provide an appropriate reference range.
Comparison of Methodologies
There are several important differences between the two approaches.
The Perpetuity Growth Model has several inherent characteristics that make it intellectually challenging. Because both the discount
rate and growth rate are assumptions, inaccuracies in one or both inputs can provide an improper value. The difference between the
two values in the denominator determines the terminal value, and even with appropriate values for both, the denominator may result
in a multiplying effect that does not estimate an accurate terminal value. Also, the perpetuity growth rate assumes that free cash flow
will continue to grow at a constant rate into perpetuity. Consider that a perpetuity growth rate exceeding the annualized growth of the
S&P 500 and/or the U.S. GDP implies that the company's cash flow will outpace and eventually absorb these rather large values.
Perhaps the greatest disadvantage to the Perpetuity Growth Model is that it lacks the market-driven analytics employed in the Exit
Multiple Approach. Such analytics result in a terminal value based on operating statistics present in a proven market for similar
transactions. This provides a certain level of confidence that the valuation accurately depicts how the market would value the
company in reality.
On the other hand the Exit Multiple approach must be used carefully, because multiples change over time. Simply applying the current
market multiple ignores the possibility that current multiples may be high or low by historical standards. In addition, it is important to
note that at a given discount rate, any exit multiple implies a terminal growth rate and conversely any terminal growth rate implies an
exit multiple. When using the Exit Multiple approach it is often helpful to calculate the implied terminal growth rate, because a multiple
that may appear reasonable at first glance can actually imply a terminal growth rate that is unrealistic.
In practice, academics tend to use the Perpetuity Growth Model, while investment bankers favor the Exit Multiple approach. Ultimately,
these methods are two different ways of saying the same thing. For both terminal value approaches, it is essential to use a range of
appropriate discount rates, exit multiples and perpetuity growth rates in order to establish a functional valuation range.