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Atypical case

Anonymous A asked on Jul 31, 2019 - 3 answers

Hello,

I wanted to share with you a case I got in a real interview (McK) when I interviewed with them a few years ago. I would be curious to know how you would approach it, since it's quite an uncommon type?

So here it is : Assume Italy wants to sell the island of Sardinia to France. What should be the price?

(edited)

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Francesco replied on Jul 31, 2019
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Hi Anonymous,

this question is in the same league as “How much would you sell the Golden Gate Bridge for” or “How much would you pay for an elephant”. The structure should be the same used to evaluate the value of a company in an M&A case.

Usually the value of a company, good or service can be structured considering three main methods:

  • Discount Cash Flow. According to this method, to find the maximum price to pay as a buyer you should:
    • Find the free cash flow generated by the company/good/service in one year. Free cash flow is different from profits, you may use profits as an approximation but let the interviewer know you are aware of the difference
    • Add free cash flow for synergies and subtract free cash flow from cannibalizations for the buyer
    • Perform a DCF analysis (you can find below a link to understand how to do that)
  • Multiple in the industry. Consider the average multiple used in equivalent transactions (eg P/E ratio). Then apply the multiple to the relevant variable of the target (eg Net Earnings of the target).
  • Asset value – identify the equity value as the fair value of total assets minus total liabilities.

In the case of Sardinia, you could use the first method, using as a reference the free cash flow generated by Sardinia in one year for the Italian Government.

The valuation should also take into account the negative cash flow that the sale would generate for the seller (relocation of people, subsidies, etc).

You can find more on the DCF method at the following link:

https://www.preplounge.com/en/consulting-forum/case-net-present-value-calculations-325

Best,

Francesco

Giulia
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replied on Jul 31, 2019
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Hi,

My approach would be to size the main source of profit of Sardinia (if I have to name 3 I would say tourism, real estate, and industry + other activities, that I would assume to be the 10% of the other 3) per annum, the profit I want to make on Sardinia's sale and then decide a payback period that would be suitable for France (e.g., 10 years !?)

E.g., for tourism, you can divide "beach tourism" and "historical tourism". For the first one you can hypothesize the number of hotels, the average number of room per hotel, the average % of rooms occupied per period of the year and the average cost per room per period of the year. Same for restaurants, beach facilities, services, ... For "historical tourism" you can do roughly the same (you could simply decide it is a percentage of the "beach tourism", I would expect it to be more spread in the year but lower)

Does it sound reasonable?

Sharma updated his answer on Jul 31, 2019

Clarifying questions: Who owns (assuming Italy govt owns this)? Why they want to sell? Key objective?

What are the current activities that happen on a daily basis? How does Italy uses this island - for some sort of trade/ uses sth grown here / uses it for tourism etc / for non-business purposes like R&D and stuff?

Population inhabited on the island? # of tourists if it is a tourist destination...

Safety issues (Natural disasters, wildlife, civilization)

Industry question: Can an island be used for any R&D activity? (if there is no / limited business on this island as per clarifying question)

Location of the island - how close to France? How close is this island to other major countries? Nearby airports...Any chance of airport establishment on island...which is the nearest civilization/ island / mainland.. how big is that... (basically judging the proximity of island to other commercial hubs and assessing its accessibility)

Is it strategic for them by any means? (France GDP % by different activities - tourism, other industries depending on what R&D can be done on island)


Approach:

1. Potential of the island (depending on objective - profitability potential from direct activities that France could establish - also take into account investments France will have to incur)

2. Cost saving avenues for France by purchasing this island

This will give total benefit for France (A)

3. Profits lost for Italy by giving this island (B)

Pricing = A - Opportunity cost for France by investing in this island and not some other avenue

(Edit: I had earlier used A+B- OC, but if i do this mistake in real interview, how to correct it?)

Then, you can decide Mode of selling: One-shot or sale and leaseback

Sale and leaseback maybe advantageous because developments can happen on island and Italy can later get it back..in the meantime, France would have popularized this island

Also, Italy can charge lesser in sale and lease back depending on the lease tenor...Also, need to take into account a multiplier on revenues when Italy gets back the island and establish clauses (penalties) for damaging island

Risk: 1) Depending on strategic location of the island, security threats in case France decides to turn hostile tomorrow

2) Rehabilititation of people and businesses in case there were any on the island...Their nationalities and rules by which they are governed...

How would you have approached this?

What am I missing (depending on your interview experience)? Look forward to your reply.

(edited)

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