Instructions: 1. Read the case carefully. 2. Complete the pro forma statements and valuation in the shaded cells. 3. In the box at the bottom of the Tab 3, provide your final recommendation to Mr. Dean as to whether $30 million for Auto City is a good starting point for negotiations Case Details: O'Ryan Auto Centers, a national auto parts chain, is seeking a way to expand into the Middle Atlantic region. Their investment bank proposes an acquisition Auto City located in Somerset, PA. Working with its investment advisor, Auto City decided it may be time to sell and is asking $30 million for the company. The investment banker for O'Ryan Auto Centers quickly brings the deal to Dudley Dean, the CFO of O'Ryan's. Mr. Dean thought the price was high when viewed as a multiple of 2020 EBITDA. However, Mr. Dean thought that O'Ryan could easily improve the cash flow of Auto City with a new inventory management system and reduce overhead expenses as well. While the growth of Auto City may slow from its double-digit rates as more competition entered the space, Mr. Dean still believes that Auto City could generate significant cash flows for O'Ryan's shareholders. Besides, through an acquisition deal, O'Ryan could quickly hold a significant market position in the Middle Atlantic region for future development. Mr. Dean is also planning to significantly change the capital structure in Auto City, in a hope to lower the financing cost. Mr. Dean sits down with his acquisition team and outlines some parameters for determining the opportunity. His goal was to determine (1) if Auto City could generate at least $1.5 million in free cash flow over the next three years with a dividend payout ratio of at least 70% to O'Ryan; and (2) whether $30 million was a reasonable starting point for the negotiations. The team was given these parameters for a 3-year forecast to answer Mr. Dean's questions. 1 2. 4 5. Sales per store growth: 15% in 2021, 12% in 2022 and 9% in 2023. Store growth (# of stores) keeps at the same historical level. Long-term growth is unclear yet. An improvement in COGS/sales to 57% over the forecast horizon. A reduction in GSA/sales to 30% from 2021 onwards, while Depreciation / Sales ratio remains the same as historical average. Cash / Sales ratio, Accounts Payable/CGS ratio, and Accrued expenses / Sales ratio remains at the same historical level as in 2020. Auto City's existing debt will be paid off after acquisition and O'Ryan will provide its $750 thousand bank line of credit (if needed) to meet any funding deficits given the growth and dividend needs. The interest rate on this line of credit is 6%. A 35% tax rate (O'Ryan's rate) will be applied to Auto City after acquisition. Free cash flow is projected to grow at 3% beyond 2023. O'Ryan's will provide all the needed financing. Its current capital structure consists of: $120 million book value of debt currently selling at 95% of book value and an average yield of 6%. b 20 million shares of stock outstanding currently trading at $72.50 per share. O'Ryan's equity beta is 1.10, the current 10-year Treasury yield is 2.0% and O'Ryan's investment banker suggests the use of a 6% equity risk premium. 6 7 8. a. " C. Income Statement ($000) Auto City 2021F 2022F 2023F For Years Ending December 31 2018 2019 2020 Sales $ 16,230 $ 20,355 $ 23,505 Cost of Goods Sold 9,430 11,898 13,612 Gross Profit 6,800 8,457 9,893 General & Selling Expense (GSA 5,195 6,352 7,471 Depreciation & Amortization 160 180 213 Interest 119 106 94 Earnings before Taxes 1,326 1,819 2,115 Taxes 546 822 925 Net Income $ 780 $ 997 $ 1,190 Dividends 199 238 # of stores 200 200 200 Calculate based on year-end debt balance ASSUMPTIONS 15.0% 57.0% 30.0% 12.0% 57.0% 30.0% 9.0% 57.0% 30.0% Sales growth COGS/sales GSA/Sales Depreciation/Sales Tax rate Interest rate Dividend payout 35.0% 35.0% % 35.0% . 4 Balance Sheet($000) Auto City 2018 2019 2020 2021F 2022F 2023F $ For Years Ending December 31 Assets Cash Accounts Receivable Inventories Current Assets 508 $ 2,545 1,630 4,683 609 $ 3,095 1,838 5,542 706 3,652 2,190 6,548 4,073 2,322 4,582 2,612 5,040 2,873 Net PPE 1,897 2,280 2,435 2,570 2,722 2,889 Total Assets 6,580 7,822 8,983 Liabilities & Shareholders Equity Accounts Payable Accrued expenses Current Portion of Long-term Debt Notes payable (if use line of credit)* Current Liabilities 1,042 1,145 125 1,325 1,432 125 1,437 1,653 125 "plug variable" 2,312 2,882 3,215 Long-Term Debt Total Liabilities 1,000 3,312 875 3,757 750 3,965 Common stock Retained earnings Shareholders Equity 1,135 2,133 3,268 1,135 2,930 4,065 1,135 3,883 5,018 Total Liabilities & Shareholders Equity 6,580 7,822 8,983 ASSUMPTIONS Cash/sales Accounts Payable/CGS Accrued expenses/sales Net Working Capital Increase in Net Working Capital CAPEX (A Net PPE+Depreciation Expense) *Footnote: After the exsiting debt is paid, a $750 thousand bank line of credit available to O'Ryan is provided when needed. WACC (O'Ryan) COST OF EQUITY Risk-Free Rate Equity Risk Premium Beta Cost of Equity COST OF DEBT Interest rate Tax Rate After-Tax Cost of Debt CAPITAL STRUCTURE Debt price Debt par value Stock price Shares (millions) Debt Weight Equity Weight WACC Valuation ($000) Auto City For Years Ending December 31 2021F 2022F 2023F EBIT Taxes NOPAT Depreciation Change in Net Working Capital CAPEX Free Cash Flow LT Growth Rate Assumption Terminal Value Free Cash Flow with terminal value WACC Enterprise Value Less: Debt Add: Cash Equity Value Instructions: 1. Read the case carefully. 2. Complete the pro forma statements and valuation in the shaded cells. 3. In the box at the bottom of the Tab 3, provide your final recommendation to Mr. Dean as to whether $30 million for Auto City is a good starting point for negotiations Case Details: O'Ryan Auto Centers, a national auto parts chain, is seeking a way to expand into the Middle Atlantic region. Their investment bank proposes an acquisition Auto City located in Somerset, PA. Working with its investment advisor, Auto City decided it may be time to sell and is asking $30 million for the company. The investment banker for O'Ryan Auto Centers quickly brings the deal to Dudley Dean, the CFO of O'Ryan's. Mr. Dean thought the price was high when viewed as a multiple of 2020 EBITDA. However, Mr. Dean thought that O'Ryan could easily improve the cash flow of Auto City with a new inventory management system and reduce overhead expenses as well. While the growth of Auto City may slow from its double-digit rates as more competition entered the space, Mr. Dean still believes that Auto City could generate significant cash flows for O'Ryan's shareholders. Besides, through an acquisition deal, O'Ryan could quickly hold a significant market position in the Middle Atlantic region for future development. Mr. Dean is also planning to significantly change the capital structure in Auto City, in a hope to lower the financing cost. Mr. Dean sits down with his acquisition team and outlines some parameters for determining the opportunity. His goal was to determine (1) if Auto City could generate at least $1.5 million in free cash flow over the next three years with a dividend payout ratio of at least 70% to O'Ryan; and (2) whether $30 million was a reasonable starting point for the negotiations. The team was given these parameters for a 3-year forecast to answer Mr. Dean's questions. 1 2. 4 5. Sales per store growth: 15% in 2021, 12% in 2022 and 9% in 2023. Store growth (# of stores) keeps at the same historical level. Long-term growth is unclear yet. An improvement in COGS/sales to 57% over the forecast horizon. A reduction in GSA/sales to 30% from 2021 onwards, while Depreciation / Sales ratio remains the same as historical average. Cash / Sales ratio, Accounts Payable/CGS ratio, and Accrued expenses / Sales ratio remains at the same historical level as in 2020. Auto City's existing debt will be paid off after acquisition and O'Ryan will provide its $750 thousand bank line of credit (if needed) to meet any funding deficits given the growth and dividend needs. The interest rate on this line of credit is 6%. A 35% tax rate (O'Ryan's rate) will be applied to Auto City after acquisition. Free cash flow is projected to grow at 3% beyond 2023. O'Ryan's will provide all the needed financing. Its current capital structure consists of: $120 million book value of debt currently selling at 95% of book value and an average yield of 6%. b 20 million shares of stock outstanding currently trading at $72.50 per share. O'Ryan's equity beta is 1.10, the current 10-year Treasury yield is 2.0% and O'Ryan's investment banker suggests the use of a 6% equity risk premium. 6 7 8. a. " C. Income Statement ($000) Auto City 2021F 2022F 2023F For Years Ending December 31 2018 2019 2020 Sales $ 16,230 $ 20,355 $ 23,505 Cost of Goods Sold 9,430 11,898 13,612 Gross Profit 6,800 8,457 9,893 General & Selling Expense (GSA 5,195 6,352 7,471 Depreciation & Amortization 160 180 213 Interest 119 106 94 Earnings before Taxes 1,326 1,819 2,115 Taxes 546 822 925 Net Income $ 780 $ 997 $ 1,190 Dividends 199 238 # of stores 200 200 200 Calculate based on year-end debt balance ASSUMPTIONS 15.0% 57.0% 30.0% 12.0% 57.0% 30.0% 9.0% 57.0% 30.0% Sales growth COGS/sales GSA/Sales Depreciation/Sales Tax rate Interest rate Dividend payout 35.0% 35.0% % 35.0% . 4 Balance Sheet($000) Auto City 2018 2019 2020 2021F 2022F 2023F $ For Years Ending December 31 Assets Cash Accounts Receivable Inventories Current Assets 508 $ 2,545 1,630 4,683 609 $ 3,095 1,838 5,542 706 3,652 2,190 6,548 4,073 2,322 4,582 2,612 5,040 2,873 Net PPE 1,897 2,280 2,435 2,570 2,722 2,889 Total Assets 6,580 7,822 8,983 Liabilities & Shareholders Equity Accounts Payable Accrued expenses Current Portion of Long-term Debt Notes payable (if use line of credit)* Current Liabilities 1,042 1,145 125 1,325 1,432 125 1,437 1,653 125 "plug variable" 2,312 2,882 3,215 Long-Term Debt Total Liabilities 1,000 3,312 875 3,757 750 3,965 Common stock Retained earnings Shareholders Equity 1,135 2,133 3,268 1,135 2,930 4,065 1,135 3,883 5,018 Total Liabilities & Shareholders Equity 6,580 7,822 8,983 ASSUMPTIONS Cash/sales Accounts Payable/CGS Accrued expenses/sales Net Working Capital Increase in Net Working Capital CAPEX (A Net PPE+Depreciation Expense) *Footnote: After the exsiting debt is paid, a $750 thousand bank line of credit available to O'Ryan is provided when needed. WACC (O'Ryan) COST OF EQUITY Risk-Free Rate Equity Risk Premium Beta Cost of Equity COST OF DEBT Interest rate Tax Rate After-Tax Cost of Debt CAPITAL STRUCTURE Debt price Debt par value Stock price Shares (millions) Debt Weight Equity Weight WACC Valuation ($000) Auto City For Years Ending December 31 2021F 2022F 2023F EBIT Taxes NOPAT Depreciation Change in Net Working Capital CAPEX Free Cash Flow LT Growth Rate Assumption Terminal Value Free Cash Flow with terminal value WACC Enterprise Value Less: Debt Add: Cash Equity Value