Part 2:

Hasbro would like to know the intrinsic value of Nerf's share capital (i.e., perform an equity valuation), as a stand-alone business. Hasbro acquired a controlling interest in Nerf as part of the Tonka Corporation take-over in 1991. Nonetheless, Nerf shares continue to trade publicly. Hasbro senior management team were shaken when they read a report by a financial analyst, who speculated that the value of Nerf's equity was only around $300m. Given that Nerf's annual turnover is in the region of $400m, this figure intuitively feels out of line. However, it is possible that Nerf's products are going out of fashion. The following is an extract from Hasbro's latest 10-K:

"The Franchise brands portfolio declined 1%. the primary drivers of the franchise brands net revenue declines were Nerf and My Little Pony products and to a lesser extent, Baby Alive and Transformers products. These decreases were offset by net revenue increases from Magic: The Gathering, products and to a lesser extent Monopoly and Play-doh products." (Hasbro, 2021: 49)

If the intrinsic value of Nerf's equity is indeed as low as $300m, Hasbro's senior management team could cut their losses and sell their holding. The costs of any business restructuring as well as the associated transaction fees (lawyers, accountants, financiers, etc.) arising as a result of the sale of Hasbro's controlling interest in Nerf would be in the region of $50m.

To aid your analysis, the following information related to Nerf has been made available:

Summarized balance sheets as at 31 December,

2019 2020

$'000s $'000s

Operating Working Capital 384,660 386,790

Net Non-Current Assets 648,260 651,120

Total Assets 1,032,920 1,037,910

Net Debt 785,720 783,520

Shareholder Equity 247,200 254,390

Total Debt and Equity 1,032,920 1,037,910

Summarized income statements for the year ended 31 December,

2019 2020

$'000s $'000s

Sales 401,970 397,540

Operating Costs 259,150 258,620

Interest Expense 20,120 20,240

Tax expense 30,675 29,670

Net Income 92,025 89,010

You have also learned the following about Nerf:

1. You can assume that the annual change in Net Non-Current Assets relates entirely to

capital expenditure.

2. The number of outstanding shares as at 31 December 2020 was 1,550,000.

3. Hasbro has a current P/E ratio of 6.10 as at the year ended 31 December 2020.

4. Nerf's revenue is forecast to decline by 1% per annum for the next four years.

5. Operating costs are forecast to decline by 0.5% per annum for the next four years.

6. The proportion of Operating Working Capital to Sales is expected to remain at its current level for the foreseeable future.

7. The proportion of Net Non-Current Assets to Sales is expected to remain at its current level for the foreseeable future.

8. Nerf expects to pay interest on net debt of approximately $20m every year.

9. Taxation rates will remain unchanged for the foreseeable future, and will remain at around 25%.

10. The company aims to retain 70% of earnings, and pays out the remainder in dividends.

11. You should use Net Debt as the Balance Sheet balancing figure in the forecasted numbers.

12. Current long-term forecasts for the industry suggest that the annual growth rate will be around 0.5%.

13. The estimated cost of equity for Nerf is 12%.

14. To compute Free Cash Flow to Equity, you should use the following formula: FCFE = Net Income - Capital Expenditure - Change in Operating Working Capital + Net Borrowing.

COMPLETE FOR HOMEWORK:

i. Using the information above, perform a valuation of Nerf's equity as at 31 December 2020 using the net book value method. State any assumptions.

ii. Using the information above, perform a valuation of Nerf's equity as at 31 December 2020 using a multiples-based method. State any assumptions.

iii. Using the assumptions provided above, perform a valuation of Nerf's equity as at 31 December 2020 applying the discounted free cash flow method. As part of your answer, you should prepare forecasted abbreviated balance sheets and income statements. State any assumptions.

iv. Based on your analysis above, advise Hasbro about the potential sale of their controlling interest in Nerf.