Minneapolis Viking Arbitrageurs，LLC (MVA), is a fledgling U.S.-based hedge fund having slightly over ＄50 million under its management. MVA specializes in owning and managing small-sized properties in agriculture, forestry, and mining. Its average investment is about $8 million.

Jim Hester, MVA's Managing Partner and Chief Investment Strategist. is examining the financial statements and other pertinent information about Fargo Durum Farms, Inc. (FDF), as a potential investment opportunity

FDF is jointly owned by two brothers, John and Matt. of the Mahoney family. With all their children graduated from North Dakota State University and currently living in Minneapolis, the brothers have decided to sell the property. Hester believes that commodity prices will continue their uptrend for extended periods and investing in a North Dakota farming operation where farm lands are still attractively priced will produce high returns for the hedge fund. Its tangible assets including working capital comprise approximately 1,500 acres of fertile and well-irrigated land, farm buildings, machinery, residential quarters, livestock，cattIe feed, seeds, gain, and so forth. FDF also carries significant intangible assets that include biological assets, patented hybrid seeds, and milk quotas.

Select data from FDF's income statement for the year ended December 2010 are presented in Exhibit 1. Exhibit 2 contains additional estimates compiled by Hester

First, Hester assesses FDF’s normalized operating income after tax. Next, he values FDF's equity using the free cash flow to the firm (FCFF) approach under the following additional assumptions.

Revenues and free cash flows will grow at a constant rate of 5% per year for the foreseeable future，

On average, FDF's operating income (EBITDA) will be 30% of gross revenues

Required capital expenditures will equal the projected depreciation & amortization expense plus 10% of the incremental revenue

Additional working capital (other than cash) equal to 15% of the incremental revenue is required

The cost of equity and weighted average cost of capital (WACC) are 14% and 11.5%, respectively

Hester presents his initial assessment and valuation of FDF to MVA's Investment Committee, The comments and suggestions from some members on the Committee are as follows:

Xavier Moreno, Commodities Analyst, suggests the use of excess earnings method (EEM) for valuing FDF and makes the following three statements in support of his preference:

1.EEM involves estimating the earnings remaining before deducting amounts that reflect the required returns to the tangible assets.

2.It is a widely used method for pricing entire private businesses such as FDF.

3.EEM is especially useful for valuing FDF as it allows for valuing working capital, fixed assets, and intangibles using different discount rates.
Jamal Bahrami, the External Consultant on the Committee differs from Hester and prefers the use of free cash flow to equity (FCFE) model. Further, he develops his own estimates for valuing FDF's equity.

Owing to the continued strength in the global demand for wheat, FDF will experience a higher annual growth rate of 10% over the next two years,2011 and 2012; thereafter, it will grow at a constant rate of 6% per year.

Next year (2011) FDF will realize ＄1,000,000 in cash flow from operations

To support its high growth needs, FDF will require ＄400，000 in new capital investment next year

The company would need additional borrowing in the amount of ＄250,000 at an interest cost of 8%

Because of illiquidity and small-firm risk premiums, the appropriate WACC and required return on equity respectively, will be higher at 12.9% and 16%

Hester made a cash offer of ＄9 million to the Mahoney brothers, However, they decided to make a counteroffer and approached Joselyn Oisen, a reputable agriculture industry analyst at the Red River Valley Consultants, LLP, for her assessment of FDF's value

Olsen prefers the guideline transactions method (GTM) using next year's expected EBITDA to value FDF and she estimates the following from the company data, market information, and her own assessments.

FDF' s expected 2011 gross revenue =＄2,800,000

2011 cost of goods sold =42% of gross revenue

2011 SG&A = 25% of gross revenue

Three recent purchase transactions of similar farms in North Dakota indicate an average MVIC (Market Value of Invested Capital) to EBITDA multiple of 9.0.

FDF commands a 30% control premium.

FDF need not incur any additional capital expenditures or borrowing

Olsen justifies her choice of the GTM approach in the following three statements:

1.The GTM approach works well for valuing FDF as it uses a multiple that specially relates to sales of entire companies. SFAS No.157 presents a fair value hierarchy that gives the highest priority to market based evidence. Further, tax courts in U.S. assessing private company valuations have generally stated a preference for valuation based on market transactions.

2.Most appraisers readily accept the valuation from GTM approach because of the reliability of transactions data.

3.The market approach to determine the value of equity is appropriate even for companies with highly leveraged financial conditions or significant volatility expected future financial performance.

Satisfied with Olsen's valuation and her methodological choice, the Mahoney brothers move ahead with their counteroffer to Hester