In this question, you are hired by Pap & Elis Partners (PE) to decide whether it is worthwhile to purchase a private firm, Young LLC. Young LLC produces a brand new communicating watch with its own apps. The following table shows the financial information for Young LLC. 2016 Income Statement and Balance Sheet Data for Young LLC. Year 2016 Year 2016 Income Statement ($ 000) Balance Sheet ($ 000) 1 Sales 12,000.00 Assets 2 Cost of Goods Sold 1 Cash and Equivalents 10,000 3 Raw Materials (1,600.00) 2 Accounts Receivable 4,000 4 Direct Labor Costs (1,800.00) 3 Inventories 5,000 5 Gross Profit 8,600.00 4 Total Current Assets 19,000 6 Sales and Marketing (1,800.00) 5 Property, Plant, and Equipment 6,000 7 Administrative (2,160.00) 6 Goodwill --- 8 EBITDA 4,640.00 7 Total Assets 25,000 9 Depreciation (600.00) Liabilities and Stockholder's Equity 10 EBIT 4,040.00 8 Accounts Payable 2,000 11 Interest Expense (net) (100.00) 9 Debt 2,000 12 Pre-tax Income 3,940.00 10 Total Liabilities 4,000 13 Income Tax (1,379.00) 11 Stockholder's Equity 21,000 14 Net Income 2,561.00 12 Total Liabilities and Equity 25,000 Young is a private firm with total assets of $25 million and annual sales of $12 million. The firm has outstanding debt of $2 million and have excess cash of $9 million, EBITDA of $4.64 million. Based on its business, the comparable companies are Microsoft Corporation (MSFT), Alphabet Inc. (GOOGL), and Apple Inc. (AAPL), which have financial data on finance.yahoo.com. The owner of Young is willing to accept a price based on the average of equity prices estimated using P/E, Enterprise Value/Sales, and Enterprise Value/EBITDA ratios for each of the comparable firm. Based on your analysis, what acquisition price will you propose to pay for the owner (the equity holder)? (If you are not able to estimate those valuation ratios for comparable firms, you can use the ratios in the following table.) Valuation ratios of comparable firms Multiple AAPL MSFT GOOGL P/E 10.1 35.3 29.9 EV/Sales 2.4 3.9 5.8 EV/EBITDA 6.9 11.3 17.7 BFIN3211 Final Spring 2016 Final Exam Due Date: May 9th, Monday (5 pm by email) 8 Your manager wants to know how much money can PE make after buying the firm. You are given the following assumptions (if you need any other assumptions, please list them explicitly in your answer): 1. Market size for this type of watch is 1 million units in 2016 and is expected to grow at the rate of 5% per year in the coming five years; 2. Market share of Young is 10%. With some sales and marketing strategies, the market share can be increased by 100 basis points per year for the coming 5 years. In other words, the market share next year will be 11%. 3. The average sales price is $120/unit in 2016 and is expected to grow at the rate of 2% per year. 4. The raw materials cost $16/unit in 2016 and is expected to grow at the rate of 4% in the coming 5 years. 5. The direct labor costs are $18/unit in 2016 and is expected to grow by 5% per year in the coming 5 years. 6. The sales and marketing costs account for 15% of the sales in 2016. To increase the sales, PE plans to increase these costs to 16% in 2017 and 17% in 2018. After that, the costs will be 18% of the sales every year. 7. The administrative costs are 18% of sales in 2016. PE plans to decrease them to 17% of sales in 2017, 16% in 2018, 15% in 2019, 14% in 2020, and 13% of sales from 2021 on. 8. The tax rate is 35% for 2016 and is expected to be at this level for the foreseeable future. 9. The depreciation expense equals 10% of Property, Plant and Equipment of that year. 10. The Capital expenditure equals the depreciation cost. 11. Your manager wants you to use the discounted cash flow approach to estimate the continuation value. 12. To get the weighted average cost of the capital (WACC), you are expected to estimate the beta of comparable firms using the stock return data of most recent 60 calendar months and use a debt-to-value ratio of 50%. (If you are not able to get the WACC, you can use 9% as WACC to continue the rest of the question. In this case, you will lose the partial points on the WACC estimation.) The net working capital for 2016 is $8 million. To improve the operational efficiency, PE hopes to reach the following goals from 2017 on: the accounts receivable will be 45 days of sales revenue, the raw materials will have 20 days of inventory, the finished goods will have 30 days of inventory; the minimum cash balance will be 30 days of sales. The wage payable will be 15 days of labor costs (including both the direct labor cost and administrative costs) and other account payable will be 60 days of raw materials and sales & marketing costs. To increase the firm value, if the interest expense in each year is half of EBIT in 2016, PE believes that the debt level is safe. In other words, PE wants to increase the debt level so that the interest expense for each year equals half of the EBIT of 2016 from 2017 on. The interest rate for the safe debt is 5% per year. After five years, the growth rate for the free cash flow is believed to be 3% per year. Based on these assumptions, what is the NPV of acquiring Young LLC.? From PEs point of view, whats IRR of this investment? (Hint: It may be easier to build an Excel workbook following what we did in class for the Ideko case to finish this problem.)