Neuqun, Inc., a publicly traded firm, is considering the acquisition of a private company, Artforever.com, which specializes in restoring damaged artwork and vintage photographs for high net worth individuals. Neuqun's CEO and chairman of the board, Willie Ray, described the motivation for the acquisition as follows: "We are running out of profitable investment opportunities in our core vintage shoe restoration business, and our shareholders expect us to continue to grow. Therefore, we must look to acquisitions to expand into growing markets."

Neuqun, Inc.'s common stock is currently trading at $50 per share, and the firm has 100,000 shares outstanding. The book value of the common stock is $20 per share. However, as mentioned by Mr. Ray, sales had been slowing recently and the board was concerned that soon the share price would also begin to flag as investors figured out that the firm was running out of positive NPV investments. The firm has $2,000,000 market value of bonds trading at a yield to maturity of 6.2%.

You have been hired as a consultant to Neuqun to evaluate the proposed acquisition of Artforever.com. There is considerable dissension among senior management and the board about whether the acquisition should be undertaken. Your job is to perform a thorough analysis of the merits of the proposed acquisition and make a recommendation to senior management.

After several meetings with Neuqun management and a review of Artforever's financial

performance and industry structure, you gathered the data shown in Table 1 below.

Artforever.com currently has $1,475,000 (market value) in long-term debt, with a coupon rate of 7%. Its cost of goods sold (COGS) is expected to be 42% of sales revenues, and selling, general and administrative (SG&A) expenses are expected to be 15 percent of revenues. The depreciation numbers listed above are already included in COGS percentage estimates. The firm's corporate tax rate is 40% and its current cost of borrowing is 6.2%.

Your research indicates that Artforever has a target debt to value ratio of 15%, based on its assessment of the probability and costs of financial distress. You note that this is different from the capital structure of Neuqun and wonder how this would factor into your analysis.

Although Artforever.com is a rapidly growing company, your analysis of industry structure suggests that competition in the art restoration market is likely to increase in the next few years. Thus, you forecast that the perpetual growth rate for free cash flows beyond 2022 will be a more modest 2.0% per year.

Your analysis of market data yielded the information in Table 2 below.

Market Data

Current yield to maturity on 30 year treasury bonds 2.50%

Current yield to maturity on 3 month treasury bills 2.0%

Most recent 1-year return on the S&P 500 5.3%

Estimate of expected average return on the S&P 500 over the next 30 years 8.0%

Your analysis of Artforever.com's industry reveals that most of the firms in the industry, like Artforever, are private firms. However, you find a close competitor, ArtToday.net, that is in the same line of business and is publicly traded. ArtToday has a long-term target debt to equity ratio of 0.75, and has been historically quite close to that target.

Your analysis of ArtToday's historical returns against the market returns yields an equity beta of 1.5. ArtToday currently has 50,000 common shares outstanding trading at $12 per share. Assume that both companies face a similar tax rate.

1. Discount Rate 2. Relevant Cash Flows

QUESTION:

Based on the calculations from the discount rate and relevant cash flows, what is the maximum price that Neuqun should pay to equity shareholders for Artforever.com? UPLOAD EXCEL FILE!!!!

Forecast Data for Artforever.com (in $'000) 2018 2019 2020 2021 2022 Sales Revenue 1,000.0 1,250.0 1,875.0 2,100.0 3,750.0 Investment in CapEx and NWC 25.0 55.0 170.0 80.0 80.0 Depreciation 15.0 30.0 50.0 72.0 80.0 Interest payments 94.4 101.4 108.6 115.9 122.4 AutoSave OFF 9 Wo... exhibits Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Times New Roman 12 V . Ai = = Insert v ab Wrap Text General V Do AY |IL|111 AM WAO Ou DX Delete v Paste V & A 191 Merge & Center TH Sensitivity $ % ) .00 00 0 Conditional Format Cell Formatting as Table Styles Format v Sort & Filter Find & Select Analyze Data A15 4 x fx A B D E F G H 1 K L M N O 0 ArtToday Data $1,475,000 7.00% Long Term Target Debt To Equity Ratio Equity Beta Common Shares Trading At Market Cap Market Debt 75.00% 1.5 50000 $12.00 per share $600,000.00 common shares trade price $450,000.00 market cap * D/E ratio 42.00% Of Sale Revenues 15.00% Of Revenues 40.00% Unlevered Beta 1.03 unlevered beta-equity beta / (1+ Debt/Equity* (1 - Tax rate)) utilize public company D/E 6.20% Cost of Debt 15.00% 2.50% 8.00% 1 2 Artforever Data 3 4 Market Value In Long-Term Debt 5 6 Coupon Rate 7 8 COGS 9 10 SG&A 11 12 Corporate Tax Rate 13 14 Current Cost of Borrowing 15 16 Target Debt to Value Ratio 17 18 Current YTM on 30 Year Treasury Bond 19 20 Estimated Expected Average Return 21 S&P 500 Over 30 years 22 23 Cost of Equity 24 23 25 26 Debt To Equity Ratio 27 28 Market Value 29 30 Equity Beta 31 32 33 34 35 36 WACC- 37 Weighted Average Cost of Capital 38 39 40 41 8.79% Required Return-R+B (Rm-R) Rf-risk free rate, B = equity beta, Rm = expected market return 17.6% formula - D/V/(1-D/V) $8,358,333.33 formula = market value debt / (D/E) 1.14 formula - UB (1 + Debt/Equity * (1 - Tax rate)) utilize private company D/E 8.03% (Equity / Equity + Debt) * Cost of Equity + (Debt/Equity + Debt) * Cost of Debt* (1 - Tax Rate) Sheet1 Sheet2 + - Ready A + 100% AutoSave OFF 9 Wo... exhibits Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments Times New Roman 12 V . Ai Insert = = ab Wrap Text General v Do IS WE 490 Ou DX Delete v Paste V A = = Merge & Center & .00 00 0 $ % ) Sensitivity Conditional Format Cell Formatting as Table Styles Format Find & Select Sort & Filter V Analyze Data C8 fix A B C D E F G H 1 j K L M N O Q R $ 1,475,000 7.00% 42% 15% 40% 6.20% 1 ArtForever.com 2 Debt Market Value 3 Coupon rate 4 COGS % of sales revenue SG&A expenses % of revenues 6 Corporate tax rate 7 Current cost of borrowing 8 9 10 11 Table 1 12 Forecast Data for Artforever.com (in $'000) 13 14 15 Sales Revenue 16 Investment in CapEx and NWC 17 Depreciation 18 Interest payments 19 2018 2019 2021 2022 1,000.0 25.0 15.0 94.4 1,250.0 55.0 30.0 101.4 2020 in S 000) 1,875.0 170.0 50.0 108.6 2,100.0 80.0 72.0 115.9 3,750.0 80.0 80.0 122.4 20 21 22 Revenues 23 COGS 24 SG&A Expenses 25 EBIT 3.750.00 1,575.00 562.50 1.612.50 645.00 1,000,00 420.00 150.00 430.00 172.00 258.00 15.0 273.00 25.0 248,00 1,250.00 525.00 187.50 537.50 215.00 322.50 30.0 352.50 55.0 297.50 1,875.00 787.50 281.25 806,25 322.50 483.75 50.0 533.75 170,0 363.75 2.100,00 882.00 315.00 903.00 361.20 541,80 72.0 613.80 80.0 533.80 967.50 80.0 1,047.50 80.0 967.50 26 Taxes 27 EBIAT 28 Depreciation 29 Operating Cash Flow 30 Investing Cash flow (incl. Working capital) 31 Free Cash Flow 32 33 34 35 36 37 38 39 40 41 Sheet1 Sheet2 + Ready a + 100%