$1$

PAMPA RV$,$ INC.

Evaluation of an Investment Opportunity

Pampa RV$,$ Inc., a publicly traded firm, is considering the acquisition of Chico Clothing

Company $($CCC$)$ for a price of $$12$ per share. CCC is a private company that specializes in

manufacturing clothing, shoes and accessories for beauty pageant contestants. The RV

business is slow, and Pampa$$s CFO believes that the acquisition of CCC will help to improve

overall profitability and provide much needed cash flow. Pampa$$s has $500,000$ shares of

common stock outstanding, currently trading at $$9\mathrm{.}75$ per share. The book value of

the common stock is $$5$ per share. Pampa also has bonds with a market value of $$3,500,000$

and a yield to maturity of $3\mathrm{.}4\%.$ Based on current market valuations, Pampa is currently

achieving its target debt to equity ratio. Pampa$$s equity beta is $0\mathrm{.}80.$

CCC is a private firm that was founded ten years ago by four sisters, who have a combined $100$

years of experience in the beauty pageant business as competitors, judges, and coaches.

CCC$$s cost of goods sold $($COGS$)$ is expected to be $38\%$ of sales revenues, and selling,

general and administrative $($SG&A$)$ expenses are expected to be $12\%$ of revenues. These

estimates are in line with the firm$$s historical performance, which is expected to continue for the

foreseeable future. The firm is $100\%$ equity financed and has $100,000$ shares of common stock

outstanding. Its equity beta is estimated to be $1\mathrm{.}353.$

CCC has experienced rapid growth over the last ten years. However, your analysis of industry

structure suggests that competition in the beauty pageant clothing and accessories market is

likely to increase in the next few years. Thus, you forecast that the perpetual growth rate for free

cash flows after five years will be a modest $1\mathrm{.}5\%$ per year.

Your team has been hired as consultants to Pampa RV to evaluate the proposed

acquisition of CCC$.$ Tables $1$ and $2$ below contain additional data that you have collected

during your research. The corporate tax rate is $40\%$ for all firms.

Table $1$

Forecast Data for Chico Clothing Company

Year $1$ Year $2$ Year $3$ Year $4$ Year $5$

Sales Revenue $300,000335,000375,000410,000575,000$

Investment in CapEx and NWC $18,00025,00040,00050,00065,000$

Depreciation$115,00030,00040,00052,00060,000$

$1$The depreciation numbers listed above are not included in COGS percentage estimates.

Table $2$

Market Data

Current yield to maturity on $30$ year treasury bonds $2\mathrm{.}50\%$

Estimate of expected average return on the S&P $500$ over the next $30$ years $7\mathrm{.}50\%$

$2$

Guidelines for Written Case Report

Prepare a report intended for the board of directors of Pampa RV that contains a valuation of CCC

and a recommendation of the potential value creation if CCC is acquired. Your report should contain

answers to the following questions.

$1)$ What is the value of Chico Clothing Company? Assume that your valuation is performed today at

Year $0,$ and that the revenues shown in Table $1$ are end$-$of$-$year year forecasts.

$2)$ Suppose Pampa RV offers to pay $$12$ for each of CCC$$s outstanding shares. If the market fully

impounds this information, what will be the new price per share of Pampa$$s commonstock?

$3)$ What is the most that Pampa should pay for CCC$?$ Why?

$4)$ Estimate the beta of the combined entity $($Pampa $+$ CCC$)$ after the merger. Based on your answer,

will the merged firm$$s cost of capital to be higher or lower than Pampa$$s current cost of capital?

Explain your answer. Hint: Firm beta is a value$-$weighted average of individual betas.

report should adhere to the following format:

$1.$ Introduction

$2.$ Analysis

$3.$ Conclusion

$4.$ Appendix

The introduction sets the stage for the work to follow and should consist of one paragraph describing the

key issue$($s$)$ that your analysis addresses.

The text of your analysis will constitute the bulk of the written presentation. Here you will explain the

process you took to develop responses to the questions above and report the results. Write in clear,

concise, and complete sentences, and avoid the use of bullet points or numbered lists.