See Wk7 FINAL EXAM.xlsx

Q4. If Company A and Company B combine, and the net income is combined. What does it mean for the current shareholders if the earnings per share stay the same but the outstanding shares increases?

Case MONMOUTH, INC. downloaded from Harvard cousepack I CERTIFY THAT 100% OF THE WORK ON THIS WK7 FINAL EXAM ASSIGNMENT TEMPLATE IS MY ENTIRELY MY OWN. I WORKED ALONE. I DID NOT CONSULT ANYONE, EITHER IN THE CLASS OR OUTSIDE THE CLASS. I DID NOT PLAGIARIZE ANYONE ELSE'S WORK. SIGNED: SEE THE IS/BS MODEL & FLOW DIAGRAM TABS -YOU ARE NOW WORKING WITH RATIOS, FORECASTS, VALUATION, POSSIBLY FINANCING Learning Objectives At the end of the course, to apply financial analysis and decision making techniques to size-up a business and make a recommendation about its value. This is a comprehensive point value is 35% of overall course grade case in the guise of an acquisition. Reading Sections of the Cohen finance book as necessary for review, and Guideline Solutions for previous weeks as necessary. Questions ANSWER IN THE TABS AS LABELLED 1 Prepare a succinct statement describing Robertson Tool's business risk, making critical judgments. 2 Based on both free cash flow valuation and market multiples valuation, what is the maximum price that Monmouth can pay for Robertson? (Determine value using both models.) Explain fully. HINT: Case Exhibit 4 offers data for FCF Model. Case Exhibit 6 offers data for MM Model. 3 Case Exhibit 5 shows a forecast of Monmouth's earnings per share. If Monmouth wants to avoid diluting the eps figures in this exhibit, calculate the maximum number of new shares that it can issue to Robertson's shareholders to accomplish the acquisition. HINT: Do this by combining the net income of both companies, solving for the number of shares that results in the target eps amount, then consider the number of shares of Monmouth already outstanding. 4 How will the Robertson shareholders react to the results of the analysis in Q3? Explain. 5 Considering all of the above, Q1-4, recommend and justify a price for this deal. OPTIONAL 6 Could a private equity firm launch a successful takeover using the LBO model? Explain why or why not. WORK ALONE ON THIS ASSIGNMENT BECAUSE IT IS A FINAL EXAM. DO NOT DISCUSS IT WITH ANYONE UNTIL THE SUBMISSION DEADLINE IS PAST. DO NOT ASK QUESTIONS OF FACILITATOR OR PROFESSOR. YOU CAN USE ANY BOOKS, NOTES, SOLUTIONS TEMPLATES - BUT YOU CAN'T DISCUSS IT WITH ANYONE. IF YOU FIND A GLITCH IN A CELL OR ELSEWHERE, FIX IT, OR EXPLAIN IT AS BEST YOU CAN. ALL TEMPLATES ARE FAMILIAR TO YOU, SO WORK WITH THEM AS YOU HAVE LEARNED TO DO. THERE IS NO SINGLE CORRECT ANSWER. THE PURPOSE OF THE ASSIGNMENT IS TO DEMONSTRATE WHAT YOU HAVE LEARNED TO DO IN THIS COURSE. THUMBNAIL SKETCH: BRIEF ANALYSIS DUPONT RATIOS HISTORICAL RATIOS B/S FORECAST I/S & TIE NORMAL DEBT RATIOWORKING CAPITAL I/S, B/S, & RATIOS STOCK PRICE MKT CAP EXTENDED ANALYSIS FULL RATIOS LIQUIDITY LEVERAGE ASSET USE PROFITABILITY VALUATION GROWTH CAPITAL BUDGETING & CAP NATCF, NPV, IRR, PAYBACK OP FINANCING ANALYSIS STEPS: 1-HISTORICAL RATIOS 2-K-WACC 3-CAPITAL BUDGETING 4-FORECAST & EFN 5-EQUITY VALUATION 6-FINANCING VALUATION DEBT EQUITY DEBT EFN EQUITY EBIT CHART income risk control mktblty flexblty timing K-WACC ENTERPRISE VALUE USING FREE CASH FLOW MARKET MULTIPLES: P/E, MV/BV, REV, EBIT INCOME STATEMENT BALANCE SHEET Revenue ASSETS LIABILITIES AND EQUITY Cost of sales Current assets Current liabilities Gross profit Cash Trade payables Other operating income Investments Other accruals Other operating expenses Trade receivables Tax liabilities Total cost and expenses Inventories Short-term loans, leases Operating profit (EBIT) Non-current assets Non-current liabilities Interest, finance costs Property, plant & equipment Loans, debt, leases due after 1 year Profit before tax Investment property Retirement benefit obligation Income tax Goodwill Deferred tax liabilities Net profit after tax Total non-current liabilities Dividends Reinvested in the business Stockholder's equity (Net worth) Preferred stock OPERATING LEVERAGE Common stock Additional paid-in-capital FINANCIAL LEVERAGE Retained earnings Total assets Total liabilities & equity WORKING CAPITAL changes spontaneously with revenuechanges spontaneously with revenue ?what levels of ca, cl, s-t loans? CAPITAL BUDGETING ?which projects to accept? FINANCING ?how much debt capacity? COST OF DEBT K-WACC COST OF EQUITY VALUATION CASH FLOW COST OF CAPITAL Cost of Capital A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 B C D Formula Equation COMPUTE WEIGHTED AVERAGE COST OF CAPITAL BASIC: COST OF DEBT: Coupon Rate Marginal Tax Rate Cost of Debt weight of debt COST OF EQUITY: Risk-Free Rate Equity Risk Premium Beta Cost of Equity weight of equity Weighted-Average Cost of Capital 7.96% given 50.0% given 4.0% b5*(1-b6) 28% 4.10% given 6.00% given 1.01 given 10.16% b11+(b13*b12) 72% 1-b8 k-d = I x (1- t) d d+e R-m - R-f k-e = R-f + [ x (R-m - R-f)] e d+e 8.43% (b8*b7)+(b15*b14)(k-d x wt-d)+(k-e x wt-e) Page 4 E F Q1-2 TAB A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 B C FREE-CASH-FLOW VALUATION OF EQUITY Assumptions: PERIOD YEAR Profit from operations (EBIT) Income tax rate Depreciation & amortization expense Net working capital from balance sheet forecast Capital expenditures Long-term growth rate Wt-Avg. C of C (K-wacc) Market Value of Debt Number of Shares Redundant Assets 2011 0 E F G H 8.43% 12.0 0.584 0.0 PERIOD YEAR D USE ANSWER BOXES BELOW STARTING AT ROW 69 2011 0 Present Value - Market Value of Debt = Valuation of Equity +Redundant assets =Adjusted Value of Equity / Number of Shares Value of Equity per Share 2013 2 5.6 40.0% 2.5 24.0 3.5 2014 3 7.2 40.0% 2.7 24.0 3.6 2015 4 8.2 40.0% 2.9 24.0 3.8 2016 5 8.2 40.0% 2.9 24.0 2.9 3.0% 2012 1 2.5 2.3 4.8 (24.0) (4.0) (23.2) 2013 2 3.4 2.5 5.9 0.0 (3.5) 2.4 2014 3 4.3 2.7 7.0 0.0 (3.6) 3.4 2015 4 4.9 2.9 7.8 0.0 (3.8) 4.0 (23.2) EBIT after tax (EBIAT) + Depreciation =Cash Flow from Operations (CFFO) +/- Change in Net Working Capital +/- Capital Expenditures =Free Cash Flow (FCF) +Terminal Value (TV) =Sum of FCF + TV 2012 1 4.2 40.0% 2.3 24.0 4.0 2.4 3.4 4.0 2016 5 4.9 2.9 7.8 0.0 (2.9) 4.9 93.3 98.2 Peer C 2.0 12.2 14.5 29.0 Peer D 1.8 12.7 12.4 22.0 51.8 12.0 39.8 0.0 39.8 0.584 68.10 MARKET MULTIPLES (COMPARABLES) VALUATION OF EQUITY Market Multiples of Peers Peer A Price /revenue market multiple of peer company 2.8 Price/EBITDA market multiple of peer company 12.8 Price /Earnings market multiple of peer company 15.0 Mkt Val of Eq/Book Val mkt mult of Equity of peer co 42.0 Target company data Target company revenue Target company EBITDA Target company earnings (net income) Target company book value of equity Target company number of shares Peer B 3.2 12.1 13.1 42.0 Average Peer E Mkt Mult 1.8 2.3 14.4 12.8 14.4 13.9 26.0 32.2 adjust function if less than 5 peers 69.8 8.2 24.4 12.1 5.8 from col B from Col G BxC C/B55 Target Co Average Aggregate Per Share Valuation Calculations Data Mkt Mult Valuation Valuation Valuation based on avg revenue market multiple 69.8 2.3 161.66 27.68 Valuation based on avg EBITDA market multiple 8.2 12.8 105.29 18.03 Valuation based on avg earnings market multiple 24.4 13.9 338.67 57.99 Valuation based on avg book value market multiple 12.1 32.2 390.59 66.88 Summary map FREE CASH FLOW MODEL REVENUE MARKET MULTIPLE EBITDA MARKET MULTIPLE EARNINGS MARKET MULTIPLE BOOK VALUE MARKET MULTIPLE CURRENT MARKET PRICE ANSWER Q1 HERE: Prepare a succinct statement describing Robertson Tool's business risk, making critical judgments. ANSWER Q2 HERE: Based on both free cash flow valuation and market multiples valuation, what is the maximum price that Monmouth can pay for Robertson? (Determine value using both models.) Explain fully. HINT: Case Exhibit 4 offers data for FCF Model. Case Exhibit 6 offers data for MM Model. Page 5 I J K L Exhibit 5 Five-Year Forecast of Monmouth, Inc. Earnings, Excluding Robertson Tool (millions of dollars except per-share data) 2003 Net Income Shares Outstanding (mil) Earnings Per Share 2004 2005 2006 2007 $ 11.0 4.21 $ 11.9 4.21 $ 12.8 4.21 $ 13.8 4.21 $ 15.0 4.21 $ 2.61 $ 2.83 $ 3.04 $ 3.27 $ 3.56 ANSWER Q3 HERE: Case Exhibit 5 shows a forecast of Monmouth's earnings per share. If Monmouth wants to avoid diluting the eps figures in this exhibit, calculate the maximum number of new shares that it can issue to Robertson's shareholders to accomplish the acquisition. HINT: Do this by combining the net income of both companies, solving for the number of shares that results in the target eps amount, then consider the number of shares of Monmouth already outstanding. ANSWER Q4 HERE: How will the Robertson shareholders react to the results of the analysis in Q3? Explain. ANSWER Q5 HERE: Considering all of the above, Q1-4, recommend and justify a price for this deal. A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 B C D E F G H I J K L M USE ANSWER BOXES BELOW STARTING AT ROW 74 USE ANSWER BOX BELOW STARTING AT ROW 72 Inputs: External Financing Needed 0 from forecast Existing Common Shares 0 from company info Existing Long-Term Debt 0 from most recent historical balance sheet Interest Rate on Existing Debt 0.0% from company info Interest Rate on New Debt 0.0% given Boom EBIT 0 arbitrarily above optimistic forecast Bust EBIT 0 arbitrarily below pessimistic forecast Income Tax Rate 40.0% from income statement Share Price $30 from market info Equity 0 from most recent historical balance sheet Results: IF DEBT IS USED IF EQUITY IS USED BOOM BUST BOOM BUST 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! EBIT Interest expense - old Interest expense - new Profit before tax Income tax Net profit Shares Shares - new Earnings per share Coverage ratio EBIT CHART $ 12.00 $ 10.00 $ 8.00 EPS $ 6.00 $ 4.00 $ 2.00 debt EPS $ 0.00 0 0 EBIT EBIT debt EPS equity EPS 0 #DIV/0! #DIV/0! 0 #DIV/0! #DIV/0! Indifference point calculation: Debt Common shares Income tax rate Interest expense 0 40.0% 0 EBIT Interest expense EBT Income tax EAT EPS #DIV/0! 0 #DIV/0! #DIV/0! #DIV/0! #DIV/0! Equity 0 40.0% 0 #DIV/0! Indifference EBIT 0 #DIV/0! #DIV/0! #DIV/0! #DIV/0! Indifference EPS Debt capacity calculation: Bust EBIT Interest coverage ratio per rating AVAILABLE FOR INTEREST Interest rate DEBT CAPACITY Existing debt EXCESS DEBT CAPACITY 0 0 #DIV/0! 0.0% #DIV/0! 0 #DIV/0! Boom 0 0 #DIV/0! 0.0% #DIV/0! 0 #DIV/0! Indiff. #DIV/0! 0 #DIV/0! 0.0% #DIV/0! 0 #DIV/0! Credit rating Interest coverage ratio Debt ratio - approximate ANSWER Q6 HERE: Could a private equity firm launch a successful takeover using the LBO model? Explain why or why not. AAA 27.3 12.6% AA A BBB BB B CCC 18 10.4 5.9 3.4 1.5 0.5 36.1% 38.4% 43.7% 51.9% 74.9% 100.6%