You are a financial analyst at GodivaSisters, a major investment banking firm. Your supervisor has just handed you a difficult assignment. You must review the work of an intern, who after given the pro forma income statement and pro forma balance sheet was asked to prepare a valuation. This intern is known to make at least 10 mistakes on each valuation attempted. Your boss wants you to identify those specific errors, suggest how they should have been done but do NOT calculate the correction, nor challenge the assumptions underlying the pro forma statements. Jakarta Partners is interested in buying South African Pharmaceuticals (SAP), a private firm. They have asked GodivaSisters to conduct a valuation of South African Pharmaceuticals. South African Pharmaceuticals has enjoyed medium but not consistent growth. GodivaSisters believes a tax rate of 25% would be appropriate. It is the firm's policy to use a 6 times EBITDA multiple in calculating terminal value for FCF. The terminal value of tax savings is calculated using a 6 times multiple method. A 10% liquidity discount is applied to acquisitions of private firms. Long term growth after the initial five year period is assumed to mirror economic growth at 5%. Currently, South African Pharmaceuticals pays a 7% interest rate on its debt. South African Pharmaceuticals does not pay a dividend. Econometric studies suggest the current risk free rate is 2%, while the market risk premium is 6%. Because this will be financed using debt, GodivaSisters management has indicated to the intern to assume a 300% debt-to-equity ratio, although the actual ratio will vary. Scoring: Correctly identifying error Va credit, proper correction Ve credit (remember you do not calculate the correction), misidentifying error - 1 credit. Note that rounding is NOT an error. Each correctly identified error including the correction (no calculation) is worth 4.5 points up to a total of 45 points. Exhibit 1: Pro Forma Income Statement Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Gross Sales 44.3 47.9 52.8 56.4 60.8 Cost of Sales 14.3 15.5 20.1 21.4 23. 1 Gross Profit 30.0 32.4 32.7 35.0 37.7 SGA (Incl.R&D) 14.4 14.8 15.6 16.3 17.1 Depr 3.5 3.5 4.0 4.3 4.7 Operating Income 12.1 14.1 13.1 14.4 15.9 Interest expense 2.4 2.4 2.4 24 2.4 Taxes 2.4 2.9 2.7 3.0 3.4 Net Income 7.3 8.8 8.8 9.0 10.1