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Business

Management

QUESTION You are the head of the acquisitions department of a company. The potential investment in a steel manufacturing company, Steel Co., is...

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QUESTION

You are the head of the acquisitions department of a company. The potential investment in a steel manufacturing company, Steel Co., is currently under review. Below is some information about the projections.

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Growth rate estimation

5%

3%

2%

4%

5%

3%

EBIT

$203,700

$157,400

$131,000

$133,000

$138,300

$140,000

Change in assets

-$115,000

-$102,000

-$83,200

-$38,000

-$38,900

-$40,200

Change in operating liabilities

$34,500

$34,500

$26,000

$9,100

$9,300

$9,600

Number of outstanding shares

27,250

Current share price

$20.91

Net debt

$240,000

WACC

8%

Inflation

3%

Effective tax rate

40%

Terminal growth rate

3%

Terminal date

Year 6

Extract from the reformatted income statement

Year 0

Year 1

Tons of steel sold

26,000

33,100

Selling price per ton

$630

$620

Cost price per ton

$540

$545

Sales

$16,380,000

$20,522,000

Cost of goods sold

$14,040,000

$18,039,500

Gross profit

$2,340,000

$2,482,500

Sales, general, and admin costs

-$234,000

-$248,250

Operating expenses

-$1,962,000

-$2,040,250

EBIT

$144,000

$194,000

Extract from the reformatted balance sheet

Year 0

Year 1

Accounts receivable

$1,723,400

$2,241,000

Inventory

$2,480,000

$3,462,000

Other current assets

$6,222,050

$5,100,860

Ending PPE (net)

$5,078,650

$5,093,140

Total assets

$15,504,100

$15,897,000

Accounts payable

$776,809

$1,042,146

Other current liabilities

$5,825,971

$5,284,134

Long-term operating liabilities

$3,941,020

$3,942,420

Capital

$4,960,300

$5,628,300

Liabilities and owner's equity

$15,504,100

$15,897,000

Answer the following questions based on this information in the corresponding answer tabs provided:

Question 1

Calculate a five-year free cash flow for Steel Co., starting from Year 2.

Question 2

Calculate the terminal value of the cash flow after Year 6.

Question 3

Calculate the discounted cash flow value for Steel Co.

Question 4

4.1 Use the valuation done as per Questions 1 to 3 and recommend whether to extend an acquisition offer and explain your decision (Max. 200 words).

4.2 Discuss how you would approach a sensitivity analysis on the valuation of Steel Co. by answering the following questions (Max. 200 words):

4.2.1 Identify the key parameters and assumptions that affect your DCF valuation of Steel Co.

4.2.2 How will the following change the valuation (increase or decrease in the calculated value of Steel Co.)?

An increase in the exchange rate (effect on exports and imports).

A decrease in the demand for steel due to an economic downturn.

Answer 1: Calculate a five-year free cash flow for Steel Co., starting from Year 2.

Free cash flow projection

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

EBIT

Effective tax rate

After-tax EBIT

Adjustments:

(Assets)

+ (Operating liabilities)

Free cash flow

Anwser 2: Calculate the terminal value of the cash flow after Year 6.

Free cash flow projection

Year 7

EBIT

Effective tax rate

After-tax EBIT

Adjustments:

(Assets)

+ (Operating liabilities)

Projected cash flow for the first year after maturity

WACC

Growth rate

Terminal value

-

Answer 3: Calculate the discounted cash flow value for Steel Co.

Free cash flow projection

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Free cash flow

WACC

8%

8%

8%

8%

8%

8%

Present value of FCF

Sum of FCF PV

Terminal value

Present value of terminal value

Net debt

Equity value of company

Number of outstanding shares

Per-share fair value estimation

0

Answer 4:

4.1 Use the valuation done as per Questions 1 to 3 and recommend whether to extend an acquisition offer and explain your decision (Max. 200 words).

Start writing here:

4.2 Discuss how you would approach a sensitivity analysis on the valuation of Steel Co. by answering the following questions (Max. 200 words):

4.2.1 Identify the key parameters and assumptions that affect your DCF valuation of Steel Co.

Start writing here (Select any three):

4.2.2 How will the following change the valuation (increase or decrease in the calculated value of Steel Co.)?

An increase in the exchange rate (effect on exports and imports).

Start writing here:

A decrease in the demand for steel due to an economic downturn.

Start writing here: