A B D E G 2 3 4 5 6 7 8 3 0 1 2 C H Lavender Repair Company, a regional hardware chain that specializes in "do it yourself" materials and equipment rentals, is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition. Doug Zona, Lavender's treasurer, and your boss, has been asked to place a value on a potential target, Lyons Lighting (LL), a chain that operates in several adjacent states, and he has enlisted your help. The table below indicates Zona's estimates of LL's earnings potential if it came under Lavender's management (in millions of dollars). The interest expense listed here includes the interest: (1) on LL's existing debt, which is $ million at a rate of 9%, and (2) on new debt expected to be issued over time to help finance expansion within the new division," the code name given to the target firm. If acquired, LL will face a 35% tax rate. Security analysts estimate LL's beta to be X. The acquisition would not change Lyons' capital structure, which is 22% debt. Zona realizes that Lyons Lighting's business plan also requires certain levels of operating capital and that the annual investment could be significant. The required levels of total net operating capital are listed in the table. Zona estimates the risk-free rate to be 7.2% and the market risk premium to be 4.75%. He also estimates that free cash flows after 2020 will grow at a constant rate of 2%. Group 3. Group 6 LL'S Debt LL's Beta (X) FCF Growth Rate (2) Group 1 Group 2 , $102.00 $103.00 $202.00 $203.00 $104.00 $204.00 Group 4 Group 5 ############# $105.00 $106.00 $205.00 $206.00 Group 7 h $108.00 $208.00 $107.00 $207.00 2019 2015 Net Sales $0.00 Cost of Goods Sold $0.00 Selling/Admin. Expense $0.00 Interest Expense $0.00 Total Net Operating Capital $150.00 2016 $60.00 $36.00 $4.80 $5.00 $150.00 2017 $90.00 $54.00 $6.10 $6.50 $157.50 2018 $112.50 $67.50 $7.60 $6.50 $163.50 $127.50 $76.50 $9.20 $7.00 $168.00 2020 $139.70 $83.80 $11.30 $8.16 $173.00 Assume that LL has 22 million shares outstanding. These shares are traded relatively infrequently, but the last trade (made several weeks ago) was at a price of $11 per share. Should Lavender's make an offer for Lyons Lighting? If so, how much should it offer per share? How would the analysis be different if Lavender intended to recapitalize Ll with 40% debt costing 10% at the end of 4 years? This amounts to $221.6 million in debt as of the end of 2019. A B D E G 2 3 4 5 6 7 8 3 0 1 2 C H Lavender Repair Company, a regional hardware chain that specializes in "do it yourself" materials and equipment rentals, is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition. Doug Zona, Lavender's treasurer, and your boss, has been asked to place a value on a potential target, Lyons Lighting (LL), a chain that operates in several adjacent states, and he has enlisted your help. The table below indicates Zona's estimates of LL's earnings potential if it came under Lavender's management (in millions of dollars). The interest expense listed here includes the interest: (1) on LL's existing debt, which is $ million at a rate of 9%, and (2) on new debt expected to be issued over time to help finance expansion within the new division," the code name given to the target firm. If acquired, LL will face a 35% tax rate. Security analysts estimate LL's beta to be X. The acquisition would not change Lyons' capital structure, which is 22% debt. Zona realizes that Lyons Lighting's business plan also requires certain levels of operating capital and that the annual investment could be significant. The required levels of total net operating capital are listed in the table. Zona estimates the risk-free rate to be 7.2% and the market risk premium to be 4.75%. He also estimates that free cash flows after 2020 will grow at a constant rate of 2%. Group 3. Group 6 LL'S Debt LL's Beta (X) FCF Growth Rate (2) Group 1 Group 2 , $102.00 $103.00 $202.00 $203.00 $104.00 $204.00 Group 4 Group 5 ############# $105.00 $106.00 $205.00 $206.00 Group 7 h $108.00 $208.00 $107.00 $207.00 2019 2015 Net Sales $0.00 Cost of Goods Sold $0.00 Selling/Admin. Expense $0.00 Interest Expense $0.00 Total Net Operating Capital $150.00 2016 $60.00 $36.00 $4.80 $5.00 $150.00 2017 $90.00 $54.00 $6.10 $6.50 $157.50 2018 $112.50 $67.50 $7.60 $6.50 $163.50 $127.50 $76.50 $9.20 $7.00 $168.00 2020 $139.70 $83.80 $11.30 $8.16 $173.00 Assume that LL has 22 million shares outstanding. These shares are traded relatively infrequently, but the last trade (made several weeks ago) was at a price of $11 per share. Should Lavender's make an offer for Lyons Lighting? If so, how much should it offer per share? How would the analysis be different if Lavender intended to recapitalize Ll with 40% debt costing 10% at the end of 4 years? This amounts to $221.6 million in debt as of the end of 2019
