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Valuation Measuring and managing the value ofpanies - Koller T.

Koller T., Murrin J. Valuation Measuring and managing the value ofpanies - Wiley & sons , 2000. - 508 p.
ISBN 0-471-36190-9
Download (direct link): valuationmeasuringandmanaging2000.pdf
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proxy for usage, such as operating income, revenues, capital employed, or number of employees.
In theory, market prices should be used for allocation purposes. For example, one hour of a headquarters accountant's time should be billed to a division based on the market price of accountants' time in general—that is, at the opportunity cost to the division. Any difference between the market price and the actual salary paid to the accountant by headquarters is a benefit or a cost to headquarters. As a practical matter, cost-based pricing is more often used because of the extra administrative costs of a market-based system. However, the basic principle remains—headquarters costs that would not be borne by the business units were they separate should not be allocated.
Determining Cash Flow Costs and Benefits of Corporate Headquarters
Attributable to headquarters are the costs and benefits that arise from combining business units under a single corporate umbrella rather than running them as separate entities. Determining these costs and benefits is a difficult exercise. At one extreme, headquarters is merely an extra level of expense, and great value can be obtained by breaking up the business units, selling them, and demolishing corporate headquarters. At the opposite extreme, headquarters can be too lean for its optimal role as agent for the capital markets in getting the highest performance from the business units, as well as capital allocation, risk management, and tax planning. Headquarters costs that should not be allocated to business units include:
• Headquarters' executive salaries, wages, bonuses, and benefits.
• Directors' fees and insurance.
• Corporate office space (buildings and land) and equipment.
• Support staff and related costs (accounting, legal, planning, personnel, communications, transportation, and administrative).
• Corporate-level advertising.
• Corporate-level research and development.
The portion of each cost to be retained at headquarters is subjective. Consider the cost of running the tax department. Each business unit would have to have its own tax department if it were an independent company. Therefore, some portion of these costs should be allocated to the business units. The relevant consideration is: What would business-unit costs be were the companies separate? To illustrate headquarters costs from an outsider's point of view, we reviewed the 25 largest companies in the Fortune
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Exhibit 14.2 1986 Headquarters Cost for 21 of the 25 Largest Industrials
f----------------------------------------------------------------------------------------------------------------*\
Company HQ cost ($ millions) HQ cost as percentage of market equity (percent) Capitalized HQ cost as percentage of total equity value (percent) HQ cost as a percentage of sales (percent)
General Motors 1,015 4.8 58 1.0
Allied Signal 249 3.6 34 2.1
Mobil 456 2.8 35 1.0
Chrysler 121 2.3 15 0.5
Atlantic Richfield 213 2.0 31 1.5
Procter & Gamble 257 2.0 15 17
Chevron 306 2.0 23 1.3
Occidental Petroleum 82 18 155 0.5
Tenneco 92 1.6 130 0.6
DuPont 304 1.5 11 1.1
Shell Oil 334 1.3 16 2.0
Boeing 100 1.3 6 0.6
R)R Nabisco 139 11 11 0.8
General Electric 389 1.0 5 1.1
USX 54 1.0 22 0.4
Rockwell International 5? 0.5 4 0.5
Exxon 406 0.8 8 0.6
Philip Morris 126 0.7 6 0.6
Amoco Corporation 113 0.7 7 0.6
United Technology 25 0.4 3 0.2
McDonnell Douglas 11 0.4 3 0.1
Average 1-ft 30 0.9
500 industrial list using fiscal 1986 publicly available data (Exhibit 14.2). We have not updated the data because segment-based reporting changed and it has become difficult to obtain the needed information—even for estimates.3
Headquarters costs averaged 1.6 percent of the 1986 year-end market value of their equity. Managers of mutual funds usually receives an average of
0.5 percent of assets under management. As a percentage of sales, headquarters costs averaged 0.9 percent in 1986.
To compare the present value of headquarters costs with the market value of equity, we capitalized the after-tax cost stream by assuming it would grow at a real rate of 2.5 percent per year and that it had the same risk as the business as a whole. The results shown in column 3 of Exhibit 14.2 are amazing.
3 To compute corporate headquarters expenses, we used the business segment exhibit in the annual report and looked up the corporate expense number located there. No guarantee exists that this number is defined in the same way from company to company because of differences in the way headquarters expenses are allocated to business units. We used the corporate expense number as reported if taxes and financing costs were not included. When they were, and when we knew the tax and financing figures, we made adjustments to estimate the pretax, prefinancing corporate expense. Occasionally, the pretax corporate expense number had to be estimated, when tax and financing expenses were unknown, by assuming interest income of 7 percent on marketable securities, a 10 percent interest expense rate on debt, and a 46 percent corporate income tax rate.
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