Acquisition of Publishing Company

At the end of 2020, you are considering acquiring the troubled publishing company Wordsworth Ltd. You believe that you can turn the company around by growing sales, improving distribution, reducing costs, and gradually reducing the inventory (all other current assets and current liabilities remain unchanged). This plan will take three years to implement, after which you expect cash flows to grow at the industry growth rate of 5% per year in perpetuity.

Wordsworth is a company with a lot of heritage having been founded in 1800 and is also a well-known British brand, respected around the world for its traditional roots (their original press is in a gothic church in the English countryside). You founded your company 10 years ago with two passionate friends and grew it with money from angel investors by focusing mainly on digital solutions.

Wordsworth and you both own a book printing plant in Europe. The secular digital migration trend and changing consumer habits mean that the expectation is that 40% less physical books will be sold in the next three years. As of 2020 Wordsworths plant has a maximum production capacity of 35,000,000 books a year, while your plant has a maximum capacity of 15,000,000 books a year. Both you and Wordsworth currently sell 10,000,000 printed books each a year.

Furthermore, Wordsworth covers mainly the UK market: 80% of sales UK, 15% of sales rest of Europe, 5% rest of the world; whilst you sell more abroad: 50% UK, 35% rest of Europe, 15% rest of the world.

The corporate tax rate is 40%. To value the investment you scribble some projections on the back of an envelope. These three-year projections are given below. Note that the interest payments are based on Wordsworths historical debt level of $160m and the risk-free rate of 5%.

Exhibit 1- Wordsworths Financial Projections

Item / Year	2021	2022	2023
Sales	100	120	140
COGS	80	60	70
SG&A	110	10	10
Depreciation	10	10	10
CAPX	10	10	10
Inventory reduction	0	6	5
Interest Payment	8	8	8

Note: All values in M.

Exhibit 2- Plant and distribution channel costs for 2020.

Item	Wordsworth	You
Plant fixed costs	30	20
Plant labour	60	60
Distribution channel	10	10

Note: All values in M.

QUESTIONS:

1. Calculate free cash flow for the all-equity financed firm for Wordsworth (excluding the terminal value) for the three years. Do not consider the synergies.

Recall that: FCF = EBIAT + DEPR Capex Delta INV

2. Estimate the potential synergies that a combination between you and Wordsworth could create. Use the information given at the beginning and the Exhibit 2 numbers. Note this question does not have a unique solution, because the results depend on the assumptions you make, hence state them clearly and show your steps and calculations, not just the final number.

3. Currently Wordsworth is a privately held firm, so its equity and debt are not publicly traded. However, one publicly traded, Marvel Corp, is in a similar line of business, and has an equity beta of 1.6. Marvel has 300 million of debt on its balance sheet. This debt is risk-free, and historically Marvel has kept its D/D+E ratio constant at 25%. The market risk premium is 7%, and the risk-free interest rate is 5%. What is the asset beta of Marvel?