The ELP Company:

The year was $2021,$ towards the end of the year. The Emerson Lake Palmer Company $($ELP$)$

was a rather small company listed in the share market. The company operated in a less volatile

industry and was still largely owned by a financially conservative family. Given that the share

trading of ELP Company was thin, the family could considerably control major decisions in

the company so far. Reflecting the COVID$-19$ crisis starting in early $2020,$ ELP had somehow

successfully managed that the only long$-$term financing source of the company was equity at

the end of $2021,$ against all odds. In the same share market, there was a group of hedge funds

that actively seek for companies that could be easily turned around to create additional value.

Jigsaw Fund $($JF$)$ was one of them. Apparently enough, ELP had come under JF$$s radar.

At the end of $2021,$ Jackson Chan, the managing partner of JF projected the $($debt$-$free$)$ free

cash flows of ELP as follows:

Year $($end of year$)$ FCF

$20225\mathrm{.}4$ mil

$20236\mathrm{.}3$ mil

$20247\mathrm{.}2$ mil

$20258\mathrm{.}1$ mil

$20269$ mil

$20279\mathrm{.}9$ mil

$202810\mathrm{.}8$ mil

After $2028,$ the growth rate of FCF is projected to be perpetually constant at $2\%$ per year.

As the ELP Company$$s shares were thinly traded, most of daily returns are zero $($e$.$g$.$ no

changes in share prices$).$ It follows that beta from regressions will be less meaningful.

However, there is one peer company in the same industry with more valid daily return series.

The Beta of that company from regressions was estimated as $1\mathrm{.}2$ while its long$-$term D$/$E ratio

was observed as $1\mathrm{.}8($seemed to also represent the average of the industry$).$ The relevant riskfree rate and the market risk premium were $5\%$ and $3\%$ respectively.

As observed towards the end of $2021,$ share price of ELP Company was $250$ while EPS was

$50.$ The number of shares outstanding was $1$ million shares. The P$/$E ratio of the industry was

$5.$

The corporate tax rate is $30\%.$ Answer the follow questions : Explain why the ELP Company $($ELP$)$ has drawn the attention of an active$-$investor

strategy such as JF at the point in time of this case study $($e$.$g$.$ late $2021).$ In your answer,also take into account surrounding economic factors. $(2)$ What is the intrinsic value of ELP Company in Jackson Chan$$s perception?

$3)$ Jackson Chan, with the backup of Jigsaw Fund $($JF$),$ plan to take over $($acquire the

majority stake ELP company$)$ and then re$-$leverage ELP Company by issuing a $15$ year

corporate debt at the fixed interest rate of $6\mathrm{.}5\%$ per year. JF plans for ELP to borrow towards its own industry$$s target. The book value of equity of ELP is $150$ mil$$.$ How much value can be added to ELP Company based on this proposal?

$4)$ What is ELP$$s WACC after recapitalisation $($based on JF$$s proposal$)?$

$5)$ In your own opinion, what could be a good use of the proceeded fund $($from new borrowing from Question $4)$ for ELP Company? Also provide your justifications.

$6)$ Estimate the financial distress $($bankruptcy$)$ cost through put option valuation. Market value of the company$$s assets before recapitalisation is $$250$ million. The variance of the company$$s share price is estimated as $2\mathrm{.}25\%($reasonable proxy for the company$$s

assets volatility since there has been no debt usage in the firm$).$ Assume a zero dividend

yield. The natural number is $2\mathrm{.}718.$ Interpret the result.

$7)$ Ignore additional perspectives of the proposal on signalling effects, voting rights,difficulties to take over corporate control, and others. If the costs involving in theprocess of the takeover deal are estimated as $$500,000,$ what is the maximum price JF should offer to buy ELP Company? Do you think Jackson Chan should pursue this proposal?