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https://www.chegg.com/homework-help/questions-and-answers/mini-case-2-capital-budgeting-neuqu-n-inc-assignment-overview-neuqu-n-inc-publicly-traded--

Mini Case #2: Capital Budgeting at Neuqun, Inc.

Assignment Overview

Neuqun, Inc., a publicly traded firm, is considering the acquisition of a private

company, Artforever.com, which specializes in restoring damaged artwork and vintage

photographs for high net worth individuals. Neuquns CEO and chairman of the board,

Willie Ray, described the motivation for the acquisition as follows: We are running out

of profitable investment opportunities in our core vintage shoe restoration business, and

our shareholders expect us to continue to grow. Therefore, we must look to acquisitions

to expand into growing markets.

Neuqun, Inc.s common stock is currently trading at $50 per share, and the firm has

100,000 shares outstanding. The book value of the common stock is $20 per share.

However, as mentioned by Mr. Ray, sales had been slowing recently and the board was

concerned that soon the share price would also begin to flag as investors figured out

that the firm was running out of positive NPV investments. The firm has $2,000,000

market value of bonds trading at a yield to maturity of 6.2%.

You have been hired as a consultant to Neuqun to evaluate the proposed acquisition

of Artforever.com. There is considerable dissension among senior management and the

board about whether the acquisition should be undertaken. Your job is to perform a

thorough analysis of the merits of the proposed acquisition and make a

recommendation to senior management.

After several meetings with Neuqun management and a review of Artforevers financial

performance and industry structure, you gathered the data shown in Table 1 below.

Forecast Data for Artforever.com (in $000)

2018 2019 2020 2021 2022

Sales Revenue 1,000.0 1,250.0 1,875.0 2,100.0 3,750.0

Investment in CapEx and NWC 25.0 55.0 170.0 80.0 80.0

Depreciation 15.0 30.0 50.0 72.0 80.0

Interest payments 94.4 101.4 108.6 115.9 122.4

Artforever.com currently has $1,475,000 (market value) in long-term debt, with a

coupon rate of 7%. Its cost of goods sold (COGS) is expected to be 42% of sales

revenues, and selling, general and administrative (SG&A) expenses are expected to be

15 percent of revenues. The depreciation numbers listed above are already included in

COGS percentage estimates. The firms corporate tax rate is 40% and its current cost of

borrowing is 6.2%.

Your research indicates that Artforever has a target debt to value ratio of 15%, based on

its assessment of the probability and costs of financial distress. You note that this is

different from the capital structure of Neuqun and wonder how this would factor into

your analysis.

Although Artforever.com is a rapidly growing company, your analysis of industry

structure suggests that competition in the art restoration market is likely to increase in

the next few years. Thus, you forecast that the perpetual growth rate for free cash flows

beyond 2022 will be a more modest 2.0% per year.

Your analysis of market data yielded the information in Table 2 below.

Market Data

Current yield to maturity on 30 year treasury bonds 2.50%

Current yield to maturity on 3 month treasury bills 2.0%

Most recent 1-year return on the S&P 500 5.3%

Estimate of expected average return on the S&P 500 over the next 30 years 8.0%

Your analysis of Artforever.coms industry reveals that most of the firms in the industry,

like Artforever, are private firms. However, you find a close competitor, ArtToday.net,

that is in the same line of business and is publicly traded. ArtToday has a long-term

target debt to equity ratio of 0.75, and has been historically quite close to that target.

Your analysis of ArtTodays historical returns against the market returns yields an equity

beta of 1.5. ArtToday currently has 50,000 common shares outstanding trading at $12

per share. Assume that both companies face a similar tax rate.

Guidelines for Case Analysis

The following aids are permitted for this analysis: You may use internet sources,

books, all posted materials (including Discussion Board Q&A), and your notes. Any

other aids are unauthorized and their use constitutes a violation of academic

integrity. This includes face-to-face or electronic correspondence concerning the

specific details of the case with any other person that is not a member of your assigned

group, whether or not they have current or past affiliation with Texas A&M University

Corpus Christi.

The case is due on the date indicated on the course schedule. Late papers may be

accepted with a reasonable excuse, but will be assessed a 20% grade reduction

penalty. Cases should be typed in 12-point font, double-spaced, with a minimum

of 1 inch margins.

The case report should be written according to the following format:

1. Introduction

2. Analysis

3. Conclusion

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

a short paragraph of the key problem(s) or issue(s) that your analysis addresses. The

analysis will constitute the bulk of the written presentation and will be a direct response

to the questions below. Use clear, concise, and complete sentences. Do not use bullet

points or numbered paragraphs. The conclusion should be a short paragraph that

summarizes the key points of the analysis.

Your report should not exceed five pages of double-spaced text with 1 inch

margins at the sides, top, and bottom of the page. This does not include exhibits of

your computations. You may submit one Excel spreadsheet that contains all your

exhibits, clearly labeled, and appropriately referenced in the text of your report.

Your analysis of Neuqun, Inc. should include answers to the questions below. Do not

write the questions verbatim in your report. Instead, write a brief introductory

statement that summarizes the question before you proceed with your analysis.

1. What discount rate is appropriate for finding the value of Artforever.com?

Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show

detailed computations in your Excel spreadsheet labeled Exhibit 1.

2. What are the relevant cash flows for valuing Artforever.com? Assume that your

valuation is performed at the end of 2017, and that the values shown in Table 1 are

end-of-year forecasts.

Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show

detailed computations in your Excel spreadsheet labeled Exhibit 2.

3. Based on your answers to questions (1) and (2) above, what is the maximum price that

Neuqun should pay to equity shareholders for Artforever.com?

Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show

detailed computations in your Excel spreadsheet labeled Exhibit 3.

4. Under what conditions might you consider recommending that management make a

higher offer than your recommended price in (3) above?

No computations are necessary, just a short discussion.

Your report is intended for the senior management of Neuqun, Inc., so be sure that

you write in a professional style that is easy to follow.