FINANCIAL ISSUES OF DIVESTITURES
Many corporations review the business portfolio to determine the operations that fit their core strategies. The firm's desire to achieve more focused business portfolio can result in operations becoming strategically redundant. The decision to sell or retain the business depends on the comparison of the after tax sales value of the business with the after tax proceeds from the sale of the business.
The following steps have to be considered to decide whether to sell or retain the business:
- Calculating after Tax Cash Flows: To decide if the business is worth selling or not, the parent must first estimate after tax cash flows of the business. To do so, the company needs the inter-company sales and the cost of services.
- Inter company sales represent operating unit revenue generated by selling products or services to another unit. The parent may value these operations using the transfer prices, which may be some market prices. If the transfer prices do not reflect the current market prices the intercompany revenue may depend on the transfer prices being higher or lower than actual market prices.
- The cost of services reflects the legal, treasury, and audit services provided by the parent company. To reflect these factors, the cash flows of the business may be adjusted for services provided by the parent at more or less of what the business has to pay for them. Operating profits may be reduced by the amount of subsidies and increased by what the business would have to pay if it purchased comparable services offered outside the parent firm.
- Estimating the Discount Rate: Once the after tax standalone cash flow over a discount rate is determined, it reflects the risk characteristics of the industry in which the business competes.
- Estimating the After Tax Market Value of the Business: The discount rate is used to determine the market value of the projected after the tax cash flows of the business. The valuation is based on the cash flows that have been adjusted for inter company revenues and services provided to the operating unit by the parent firm.
- Estimating the Value of the Business to the Parent: The after tax Equity Value (EV) of the business as part of the parent is estimated by subtracting the market value of the business liabilities from its market value (MV) as a standalone operation. EV = MV - L.