Charging Corporation and Sparking Electrical Company are competitors in the business of electrical components distribution. Sparking is the smaller firm and has attracted the attention of the management of Charging, for Sparking has taken away market share from the larger firm by increasing its sales force over the past few years. Charging is considering a takeover offer for Sparking and asked you to serve on the acquisition valuation team that will turn into due diligence team if an offer is made and accepted. Given the financial information and proposal assumptions that follows, how would you respond to (a) and (b)?

Assumptions

1. i) Sparking would become a wholly owned subsidiary of Charging.

2. ii) Revenues will continue to grow to 4.3% for the next five years and will level off at 4% thereafter.

• iii) The cost of goods sold will represent 95% of revenue going forward.

1. iv) Sales-force layoff will reduce Sales, general and Administration (SG&A) expenses to $22 million next year, with a 2% growth rate going forward.

2. v) These layoff and other restructuring charges are expected to result in expensed restructuring charges of $30 million, $15 million, and $5 million (respectively) over the three years period.

3. vi) Noncash expenses are expected to remain around $7 million going forward.

• vii) Interest expense are expected to remain around $11.5 million going forward
• A tax rate of 31% is assumed going forward.

1. ix) Chargings cost of equity is 12%

2. x) Sparkings current market capitalization is $250 million.

3. xi) Charging will offer Sparking a takeover premium of 20% over current market capitalization.

QUESTIONS

a. Make your recommendation about whether or not the acquisition should be pursued.

b. If Charging has 30 million shares outstanding that are currently trading at $60.00, then how many shares should Charging offer for every share of Sparking?

Sparking Electrical Company Condensed Income Statement Previous five years (in $ million) 2009 2008 2007 2006 2005 Revenues 1,626.50 1614.10 1485.20 1380.50 1373.40 - Cost of goods sold 1,488.10 1490.90 1359.50 1271.40 1268.00 Gross profits 138.40 123.20 125.70 109.10 105.40 SG&A expenses 41.1 36.8 41.2 35 36.1 Noncash expense (depreciation 7.3 & amortization) 6.7 7.1 6.6 6.4 Less: Operating expense 48.4 43.5 48.3 41.6 42.5 Operating income 90.00 79.70 77.40 67.50 62.90 Interest expense 11.5 12 12 12 12 Earnings before taxes 78.5 (EBT) 67.70 65.40 55.50 50.90 Less: Taxes paid (31%) 24.3 20.8 19.9 16.8 15.3 Net Income 54.2 46.90 45.50 38.70 35.60 Sparking Electrical Company Condensed Balance Sheet Previous Year ($ million) Item 2009 Current Asset 12.2 Fixed Asset 347.8 Total Asset 360 Current liabilities 10.1 Long Term debt 150 Total Liabilities 160.1 Shareholders' equity 199.9 Total Liabilities and equity 360 Sparking Electrical Company Condensed Income Statement Previous five years (in $ million) 2009 2008 2007 2006 2005 Revenues 1,626.50 1614.10 1485.20 1380.50 1373.40 - Cost of goods sold 1,488.10 1490.90 1359.50 1271.40 1268.00 Gross profits 138.40 123.20 125.70 109.10 105.40 SG&A expenses 41.1 36.8 41.2 35 36.1 Noncash expense (depreciation 7.3 & amortization) 6.7 7.1 6.6 6.4 Less: Operating expense 48.4 43.5 48.3 41.6 42.5 Operating income 90.00 79.70 77.40 67.50 62.90 Interest expense 11.5 12 12 12 12 Earnings before taxes 78.5 (EBT) 67.70 65.40 55.50 50.90 Less: Taxes paid (31%) 24.3 20.8 19.9 16.8 15.3 Net Income 54.2 46.90 45.50 38.70 35.60 Sparking Electrical Company Condensed Balance Sheet Previous Year ($ million) Item 2009 Current Asset 12.2 Fixed Asset 347.8 Total Asset 360 Current liabilities 10.1 Long Term debt 150 Total Liabilities 160.1 Shareholders' equity 199.9 Total Liabilities and equity 360