KENNECOTT COPPER CORPORATION CASE REPORT
1. Analyze the economic rationale of the Carborundum acquisition. Under what conditions an acquisition would be expected to add to shareholder value in general? Do any of these reasons apply to Carborundum acquisition?
Prior to the consideration of Carborundum as an acquisition target, Kennecott, a copper company, pursued an acquisition of Peabody, a coal company, for $285 million in cash in 1968. There are two main rationales behind the acquisition of Peabody by Kennecott. First, to stabilize the high volatility in Kennecott’s profitability due to sharp changes in copper prices and increasing competition from copper producers in Chile, Zambia, Peru, and Zaire, LDCs whose reliance on copper…show more content… Just as the First Boston report noted, “the Board’s legal responsibility was to exercise reasonable business judgment in the best interests of the Corporation and its continuing body of shareholders and that the Board was not required to act in accordance with the special interests of particular shareholders, such as those seeking short-term market profits, i.e. those who might prefer the partial liquidation of the Corporation’s earnings base or its takeover by another, “ the valuation methodology used by Kennecott’s management appears not to have been in the interest of its profit-oriented shareholders (page 9).
3. Use the information given in Exhibit 7 to determine the value of Carborundum to Kennecott using the Flow-to-Equity Method. Assume that the market risk premium (ErM – rf) equals 8.3%.
Let’s assume we will use the Flow-to-Equity method to value the company, thus we would need to calculate the free cash flow to equity. Since Exhibit 7 of the case explicitly provides the net income, the correct approach to derive from net income to free cash flow to equity is by adding depreciation and goodwill amortization, net borrowings and tax-loss carry forwards, and subtracting increases in working capital and capital expenditures.
After calculating the free cash flow to equity, we would need to calculate the appropriate discount rate to
