HARVARD EXTENSION SCHOOL
Mergers and Acquisitions MGMT E-2720
Spring 2014
Midterm Case – Sterling Household Products Company
Contents
a.How much business risk is associated with Sterling’s proposed acquisition of the germicidal, sanitation, and antiseptic products unit of Montagne Medical? 3
What is the cost of equity capital appropriate for evaluating the free cash flow associated with this investment? 4
What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow? 4
b.What are the amounts and timing of the acquisition investment’s free cash flow from 2013 through 2022? 4
What is the terminal value of the final 10 years of the acquisition, as of 2022? 5
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The terminal value of the final 10 years was estimated as a multiple of nine times the free cash flow from 2022.
Terminal Value = 23,386 * 9 = 210,475
The terminal value is 210.5 million USD.
What is the net present value (NPV) to Sterling of this base investment?
NPV = DCF2013-2022 + Terminal value + value of excess cash – Purchase price
(see excel sheet/Target for more details)
Excess cash = Cash - Minimum cash
Excess cash = 0 - Revenue * Working capital rate
Excess cash = - 29,8m
NPV = 148.9m + 210.5m + (-29.8m) – 265.0m = 64.6m
Net present value of this base investment is 64.6 million USD.
What are the amounts and timing of the follow-up expansion investment opportunity’s free cash flow from 2013 through 2022?
(see excel sheet/Expansion for more details)
What is the terminal value of the final 10 years of the follow-up acquisition, as of 2022?
The terminal value of the final 10 years of the follow-up was estimated as a multiple of nine times the free cash flow from 2022.
Terminal Value = 11,942 * 9 = 107,477
The terminal value of the follow-up is 107.5 million USD.
What is the net present value of this follow-up investment and the combined base and expansion investments?
(see excel sheet/Expansion for more details)
NPV = DCF2013-2022 Follow-up + Terminal ValueFollow up + NPVBase investment
NPV = -5.3m + 107.5m + 64.6m = 166.8m
Net present value of the combined follow-up investment and the base investment is 166.8
3. Compute the unlevered free cash flow and the interest tax shields from 2008 to 2012 based on estimates provided in Exhibit 1 and Exhibit 6. (3 points)
What are the expected non-operating cash flows when the project is terminated in Year 10?
We assume that risk free rate (Rf) equals rate of long-term Treasury Bonds (as the project’s life is 10 years), so Rf = 9.5%.
See Table 1: Expected non-operating cash flow when the project is terminated at year 4 = 165,880$
In the attached file, there are calculations of relevant cash flows and their different impacts on the expansion analysis. The capital expenditure of the first year comes out to be about $43,500 which is financed via a 6% loan with monthly payments. Amortization of $9,300 per year will be charged to depreciate the capital expenditure which yields a tax shield (20% tax) of $1,860 annually. The per month interest payment comes out to be $1,927.95 and the entire loan will be paid off in two years. As a result, the annual interest tax
In conjunction, it might also be advantageous for the company to do an analysis that will provide additional insight into what the investment can generate for the company in the future. This type of analysis is known as a projected (pro forma) balance sheet, authors Besley & Brigham of the text book CFIN 4, 4th Edition explain, “The objective of this part of the analysis is to determine how much income the company will earn and then retain for reinvestment in the business during the forecast year.” (Besley & Brigham, 2015, pg. 296). Clearly, there are additional tools, analysis, and evaluations that can be performed however, this would be a good starting point for RCC to determine which may be the best course of action to take as it pertains
It is important to look at it because it is a measure that investors can use to evaluate the financial health of the company. However Liedkte being more conservative he says that the combined businesses could achieve and EBIT of 9 % and when looking at the projections for Mercury from 2007-2011 we can see a growth in earnings. So then what are the cash flows if Liedtke thinks the combined businesses will have a revenue growth of 2% in year 2011 considering we discounting back to 2006. We need to calculate the Free Cash Flow (FCF) in order to determine if the Net profit Value is positive or negative. Knowing that we will know if the acquisition should be undertaken. When looking at the excel sheet we can see that the NVP using the discount rate given by the case 7.65 % with a growth rate of 3 % gives us an NVP= $ 275,399.78. Therefore the NVP’s value compares the value of the investment made today to the same value of the amount in the future. So that is the amount AGI needs to pay up front. The free cash flows are made from the financial statement given in the case and were determined using the FCF method; EBIT (1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital
Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value.
“Wheels Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35%,” (Argosy University, 2015).
The remaining EPA term of 23 years at the end of the initial tenor of the Term Loan makes the refinancing of the balloon payment likely. The Analyst notes that if no refinancing is available, the balloon payment at the end of the initial term of the loan will be fully repaid two years prior to the EPA expiry in 2048, under the conservative P99 scenario, and solely based on contracted cash flows.
a. What was TECO’s expected rate of return at the beginning of 1992? Value Line estimate
B – As this is not possible to trace back from the information we can retrieve from the case. As the decision to expand or not to expand lies at the responsibility of the managers at the firm, probabilities are not able to be calculated here. However, the manager will always choose the option with the higher NPV.
Part 2 of this course continues with an overview of the merger and acquisition process, including the valuation process, post merger integration and anti-takeover defenses. The purpose of this course is to give the user a solid understanding of how mergers and acquisitions work. This course deals with advanced concepts in valuation. Therefore, the user should have an understanding of cost of capital, forecasting, and value based management before taking this course. This course is recommended for 2 hours of Continuing Professional Education. In order to receive credit, you will need to pass a multiple choice exam
Q2: Use the FCF Valuation Template below to modify the analysis in the case, Ex. 6 (incorrectly labeled Ex. 5), calculating and defending an estimate of Crocs value. Soln: The preferred method to determine a company’s going-concern value by adjusting for risk and time. Simply put, the value of equity = value of firm – value of debt. So to find the intrinsic or fair values of Crocs, the forecast numbers from exhibit 6 were plugged into the provided template and appropriate entries from the balance sheet and income statement were entered. Assumptions: The depreciation and amortization amounts, capital expenditures were pulled directly from exhibit 6 assuming them to be incremental. Other assumptions include the discount rate at 10.96%, the long-term growth at 6%, and market value of debt as zero and no redundant assets. The firm will have perpetual growth after 4 years at a rate of 6%. The free cash flows along with terminal value calculated are listed below:
2012 Yearly Growth Future Value Discounted Perpetuity Value Present Value 2,151.41 2013 2,237.46 2014 2,326.96 18,023.58 28,024.79 3-Y Shares Outstanding Fair Value Desired M.O.S. Buy Under Current Price Actual M.O.S. 4.66