Saito Solar Case

Saito Solar Case

1. Explain what is going on in the case (short description a paragraph will suffice) Make sure that you identify the main issues. 4 points

This case is about Saito Solar’s owner, Takuya Saito, getting approached by an investment bank to sell his company. The case also talks about the recent boom in solar energy and the new feed-in tariff imposed by the Japanese Government, which has caused a surge in solar production. Mr. Saito has 2 silent partners and the case is about the discussion of valuation of their company. The 2 silent partners disagree on the valuation of the company but all 3 partners are intrigued by the potential buyer. The company’s finance manager prepared the 5-year cash flow projections and all 3 partners thought the projections were reasonable. Ultimately the partners are trying to formulate a valuation to bring to the investment bank.

1. Using the discounted cash flow approach, why are projected free cash flows, rather than profits, used in estimating the value of the firm?  4 points

DCF approach is a valuation method that values a company by forecasting its future cash flows. Then the NPV can be calculated by discounting all the future cash flows. Projected free cash flows represent how well the company will perform in dollars and the amount of expenditure and depreciation effect on the value of the company. Profits do not consider these factors. Profits are earnings of a company. It is an accounting value based on accounting rules and does not mean the company will generate the same amount of cash value. Because of this, projected free cash flows are more suitable to estimate the value of a company.

Discounted cash flows use future free cash flow projections and discounts them to get the present value estimate. This is because cash flows in the future are not worth as much as cash received in the present. The reason that free cash flow is used instead of profit is because profit includes non-cash items such as non-cash outflows and intangibles like depreciation. Because we need to discount future value to present value we have to use cash flows, because discount rates are for cash flows not for profits.

1. What is the role of WACC in valuation?  2 points

Weighted average cost of capital is a way to calculate the cost of capital of a company based on proportionately weight of each category of capital. When evaluating investments, securities analysts use WACC as a tool to help them calculate which investment is more valuable. In a DCF approach, WACC is used to discount the future free cash flow and terminal value to get the net present value of a specific investment or company. For investors the WACC is the minimum rate of return for them. When the return is less than the WACC, investors will stop their investments in the company.

The WACC in valuation is crucial. The WACC is accounted with the growth factor, which is important in the valuation of Saito Solar. The WACC is also required for using the discounting cash flow method.

1. Based on Mr. Suzuki’s estimate of 1-3% growth rate of Saito Solar’s free cash flows over the next 20 years,  how much would Saito Solar be valued at? The owners’ required rate of return was 10%.   4 points

To find this we look at the data in Appendix 3. It gives us the projected cash flows in the future from 2013-2017. The projected free cash flows are 396.4, 465.2, 538.9, 607.1, and 628.4. We need to discount each of these back to present value at the 10% rate, and sum them.

396.4/(1.1) + 465.2/(1.1^2) + 538.9/(1.1^3) + 607.1/(1.1^4) + 628.4/(1.1^5) = 1954.55