The Case

Charging Corporation and Sparking Electrical Company are competitors in the business of electrical components distribution. Sparking is the smaller firm and has attracted the attention of the management of Charging, for Sparking has taken away market share from the larger firm by increasing its sales force over the past few years.Charging is considering a takeover offer for Sparking and asked you to serve on the acquisition valuation team that will turn into due diligence team if an offer is made and accepted. Given the financial information and proposal assumptions that follows, how would you respond to (a) and (b)?

Sparking Electrical Company

Condensed Income Statement

Previous five years (in $ million)

2009

2008

2007

2006

2005

Revenues

1,626.50

1614.10

1485.20

1380.50

1373.40

- Cost of goods sold

1,488.10

1490.90

1359.50

1271.40

1268.00

Gross profits

138.40

123.20

125.70

109.10

105.40

SG&A expenses

41.1

36.8

41.2

35

36.1

Noncash expense (depreciation & amortization)

7.3

6.7

7.1

6.6

6.4

Less : Operating expense

48.4

43.5

48.3

41.6

42.5

Operating income

90.00

79.70

77.40

67.50

62.90

- Interest expense

11.5

12

12

12

12

Earnings before taxes (EBT)

78.5

67.70

65.40

55.50

50.90

Less: Taxes paid (31%)

24.3

20.8

19.9

16.8

15.3

Net Income

54.2

46.90

45.50

38.70

35.60

Sparking Electrical Company Condensed

Balance Sheet Previous Year ($ million)

Item

2009

Current Asset

12.2

Fixed Asset

347.8

Total Asset

360

Current liabilities

10.1

Long Term debt

150

Total Liabilities

160.1

Shareholders' equity

199.9

Total Liabilities and equity

360

Assumptions

i)Sparking would become a wholly owned subsidiary of Charging.

ii)Revenues will continue to grow to 4.3% for the next five years and will level off at 4% thereafter.

iii)The cost of goods sold will represent 95% of revenue going forward.

iv)Sales-force layoff will reduce Sales, general and Administration (SG&A) expenses to $22 million next year, with a 2% growth rate going forward.

v)These layoff and other restructuring charges are expected to result in expensed restructuring charges of $30 million, $15 million, and $5 million (respectively) over the three years period.

vi)Noncash expenses are expected to remain around $7 million going forward.

vii)Interest expense are expected to remain around $11.5 million going forward

viii)A tax rate of 31% is assumed going forward.

ix)Charging's cost of equity is 12%

x)Sparking's current market capitalization is $250 million.

xi)Charging will offer Sparking a takeover premium of 20% over current market capitalization.

QUESTIONS

a)Make your recommendation about whether or not the acquisition should be pursued.(7 marks)

b)If Charging has 30 million shares outstanding that are currently trading at $60.00, then how many shares should Charging offer for every share of Sparking? (3 marks)