Investco is a high-tech manufacturing company that has operated for 10 years and has grown organically over time. However, the company has hovered around break-even for a number of years until recently. A private equity firm owns Investco The Board of Investco now wishes further growth and faster since it is now earning decent profits and has positive cash flows. Investco is considering a purchase of Target, a public company and one of its suppliers. About 10% of Target sales are to Investco. The two Boards have been discussing a purchase price of $660 million, to be paid in full at the time of purchase. This is the final offer by Investco. This determination of price is based on three times revenue. This is a multiple used by the private equity firm in other deals but not necessarily for this industry. The net assets of Target are valued at $400 million since it does have identifiable intangible assets and relationships that could be used by Investco to expand its sales. The private equity firm dictates that Investco should earn a 10% return on revenue and have a 10-year cash payback period for its investments. Also, an EBITDA return on sales of 20% would be desirable. If the purchase is completed, a parent - subsidiary structure will be implemented and Target will be privately owned by Investco. Eventually, the private equity firm would like Investco to go public where it feels earnings per share (EPS) will be an important market driver. The private equity firm believes a minimum target EPS of $0.30 is essential to go public at a $10 price per share in the high-tech industry and growth of at least 20% annually. Use the following information to answer the questions below. Income Statement Investo 2019 2018 700 . 100 Target 2019 2018 220 200 18 160 (in millions) Revenue Depreciation Cost of sales Gross profit Operating expenses Operating profits Finance costs Profit before tax Tax expense Net income Notes: 1 Target has issued 200 million shares at $0.50 per share 2 The current market price of Target shares are $4.50 per share 3 Similar companies to Target have a Price / Earnings (P/E) ratio of 20 4 Target could increase its long-term borrowings to equity to 2 to 1 5 Investco could increase its long-term borrowings to equity to 3 to 1 6 Investco has 200 million shares outstanding recorded at $1.00 book value each 7 Investco shares have an estimated fair value of $10 per share if issued 4 2018 Statement of Financial Statement | Invest (in millions) 2019 Cash 100 Other current assets 220 Fixed assets 1,000 Total assets 1,320 75 Target 2019 2018 12 170 155 183 365 199 1.174 393 191 44 Current liabilities Long-term borrowings Total debt Share capital Retained earnings Total equity Total liabilities & equity 461 584 1,045 200 566 959 200 75 235 100 30 130 365 275 1,320 215 1,174 320 Statement of Cash Flows Invest Target 2019 2019 60 100 207 (in millions) Net Income Depreciation Change in working capital Operating cash flows Purchase fixed assets Financing Change in cash Opening cash Ending cash 200 744 EBITDA Note: Lenders for business expansion or purchases support their loan approvals by collateral, cash flows and/or industry standards such as 3 to 1 equity. Incremental loans will also depend on the amount of existing loans and ratio trends. Share investors for business expansion support their investments by forecasting profitable growth, dividends and/or price earnings (PE) multiple levels. High-tech companies can have PE multiples in excess of 30. Growth companies often do not pay dividends but attract investors because of growth prospects. . 1. Calculate 8 ratios for both companies that assess the financial strength and financial state of these companies. (Calculate to two decimals) 2. Prepare common size financial statements for the two companies. 3. Assess the potential impact on Investco if Target is purchased given the ratios in questions 1 and 2. Without considering the recording of the contemplated transaction and financing, how would the purchase likely affect Investco's financial state? Potentially what is the impact on Investco's ratios on a combined basis? Answer, better or worse and why. No calculations required. 4. Assess whether the proposed share purchase price is reasonable. Recommend a final price for the shares of Target to the Board of lovestco 5. How much do you think Investco could borrow and/or issue shares for to finance the purchase of Target shares? Consider the following options. Option (1) - Investco borrows at 5% and then buys Target shares. Calculate the amount of borrowing and the impact on its net income and earnings per share. Assume Combined Operating profits are $130 million including synergies from the purchase. Its interest cost on prior borrowings is $22 million and its tax rate is 15.5%. Assume opening equity is $215 million (2018). Option (2) - Investco issues more of its own shares to the private equity firm for cash ($10 per share) and then buys Target shares. Calculate the amount of shares issued and the impact on its net income and earnings per share. Assume Combined Operating profits are $130 million including synergies from the purchase. Its interest cost on prior borrowings is $22 million and its tax rate is 15.5%. Assume opening equity is S215 million (2018). Option (3) - Investco finances 50% with long-term borrowings and 50% with its shares using the assumptions above in this question. Note: for these calculations, the Board of lavestco wants to know what 2019 would look like if the purchase had happened as at the beginning of 2019. 6. Which working capital management issues would you want to review with the Board of lovestco? Note: neither company has paid dividends to-date. They are considered growth companies. The companies will be consolidated (combined for external reporting) after the purchase. Target incremental borrowing capacity is considered an opportunity to fund asset growth in the future and banks / lenders will not allow these funds to be up-streamed to Investco for the initial purchase. Investco is a high-tech manufacturing company that has operated for 10 years and has grown organically over time. However, the company has hovered around break-even for a number of years until recently. A private equity firm owns Investco The Board of Investco now wishes further growth and faster since it is now earning decent profits and has positive cash flows. Investco is considering a purchase of Target, a public company and one of its suppliers. About 10% of Target sales are to Investco. The two Boards have been discussing a purchase price of $660 million, to be paid in full at the time of purchase. This is the final offer by Investco. This determination of price is based on three times revenue. This is a multiple used by the private equity firm in other deals but not necessarily for this industry. The net assets of Target are valued at $400 million since it does have identifiable intangible assets and relationships that could be used by Investco to expand its sales. The private equity firm dictates that Investco should earn a 10% return on revenue and have a 10-year cash payback period for its investments. Also, an EBITDA return on sales of 20% would be desirable. If the purchase is completed, a parent - subsidiary structure will be implemented and Target will be privately owned by Investco. Eventually, the private equity firm would like Investco to go public where it feels earnings per share (EPS) will be an important market driver. The private equity firm believes a minimum target EPS of $0.30 is essential to go public at a $10 price per share in the high-tech industry and growth of at least 20% annually. Use the following information to answer the questions below. Income Statement Investo 2019 2018 700 . 100 Target 2019 2018 220 200 18 160 (in millions) Revenue Depreciation Cost of sales Gross profit Operating expenses Operating profits Finance costs Profit before tax Tax expense Net income Notes: 1 Target has issued 200 million shares at $0.50 per share 2 The current market price of Target shares are $4.50 per share 3 Similar companies to Target have a Price / Earnings (P/E) ratio of 20 4 Target could increase its long-term borrowings to equity to 2 to 1 5 Investco could increase its long-term borrowings to equity to 3 to 1 6 Investco has 200 million shares outstanding recorded at $1.00 book value each 7 Investco shares have an estimated fair value of $10 per share if issued 4 2018 Statement of Financial Statement | Invest (in millions) 2019 Cash 100 Other current assets 220 Fixed assets 1,000 Total assets 1,320 75 Target 2019 2018 12 170 155 183 365 199 1.174 393 191 44 Current liabilities Long-term borrowings Total debt Share capital Retained earnings Total equity Total liabilities & equity 461 584 1,045 200 566 959 200 75 235 100 30 130 365 275 1,320 215 1,174 320 Statement of Cash Flows Invest Target 2019 2019 60 100 207 (in millions) Net Income Depreciation Change in working capital Operating cash flows Purchase fixed assets Financing Change in cash Opening cash Ending cash 200 744 EBITDA Note: Lenders for business expansion or purchases support their loan approvals by collateral, cash flows and/or industry standards such as 3 to 1 equity. Incremental loans will also depend on the amount of existing loans and ratio trends. Share investors for business expansion support their investments by forecasting profitable growth, dividends and/or price earnings (PE) multiple levels. High-tech companies can have PE multiples in excess of 30. Growth companies often do not pay dividends but attract investors because of growth prospects. . 1. Calculate 8 ratios for both companies that assess the financial strength and financial state of these companies. (Calculate to two decimals) 2. Prepare common size financial statements for the two companies. 3. Assess the potential impact on Investco if Target is purchased given the ratios in questions 1 and 2. Without considering the recording of the contemplated transaction and financing, how would the purchase likely affect Investco's financial state? Potentially what is the impact on Investco's ratios on a combined basis? Answer, better or worse and why. No calculations required. 4. Assess whether the proposed share purchase price is reasonable. Recommend a final price for the shares of Target to the Board of lovestco 5. How much do you think Investco could borrow and/or issue shares for to finance the purchase of Target shares? Consider the following options. Option (1) - Investco borrows at 5% and then buys Target shares. Calculate the amount of borrowing and the impact on its net income and earnings per share. Assume Combined Operating profits are $130 million including synergies from the purchase. Its interest cost on prior borrowings is $22 million and its tax rate is 15.5%. Assume opening equity is $215 million (2018). Option (2) - Investco issues more of its own shares to the private equity firm for cash ($10 per share) and then buys Target shares. Calculate the amount of shares issued and the impact on its net income and earnings per share. Assume Combined Operating profits are $130 million including synergies from the purchase. Its interest cost on prior borrowings is $22 million and its tax rate is 15.5%. Assume opening equity is S215 million (2018). Option (3) - Investco finances 50% with long-term borrowings and 50% with its shares using the assumptions above in this question. Note: for these calculations, the Board of lavestco wants to know what 2019 would look like if the purchase had happened as at the beginning of 2019. 6. Which working capital management issues would you want to review with the Board of lovestco? Note: neither company has paid dividends to-date. They are considered growth companies. The companies will be consolidated (combined for external reporting) after the purchase. Target incremental borrowing capacity is considered an opportunity to fund asset growth in the future and banks / lenders will not allow these funds to be up-streamed to Investco for the initial purchase