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 4.1% 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%.

Scoring: Correctly identifying error credit, proper correction credit (remember you do not calculate the correction), misidentifying error credit. Note that rounding is NOT an error. Each error 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	2.4	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

Exhibit 2: Pro Forma Balance Sheet (Millions)

	0	1	2	3	4	5
Cash	10.0	15.8	28.1	40.1	53.4	68.2
NWC	25.1	21.6	13.6	5.6	-2.4	-10.4
PPE	30.0	35.0	39.5	43.5	47.2	50.5
Debt	58.0	58.0	58.0	58.0	58.0	58.0
Equity	7.1	14.4	23.2	31.2	40.2	50.3

Exhibit 3: Information from Comparable Companies & Beta Calculations

	Sales (millions)	Tax Rate	D/E	Levered Beta	Unlevered Beta Calculated
Galaxy Drugs	300	0.300	.40	1.7	2.2
Smith-Jones	150	0.250	.30	1.4	1.7
Boleche	200	0.350	.45	1.3	1.7
Nu-Boda	400	0.300	.20	0.9	1.0
Average		0.300			1.65

Exhibit 4: Cost of Equity Calculation

2% +1.65 * 6% = 11.9%

Exhibit 5: Debt

Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Beg Debt 58 58 58 58 58 Payments End Debt 58 58 58 58 58

Exhibit 6: Subsidiary Schedules

		1	2	3	4	5
Depreciation Calculation
EBITDA		15.6	17.6	17.1	18.7	20.6
-EBIT		12.1	14.1	13.1	14.4	15.9
Depreciation		3.5	3.5	4.0	4.3	4.7
Cap Ex Calculation
Beg Net PPE		30.0	35.0	39.5	43.5	47.2
End Net PPE		35.0	39.5	4.35	47.2	50.5
Depreciation		3.5	3.5	4.0	4.3	4.7
CapEx		5.0	4.5	4.0	3.7	3.3
FCF/DCF Calculation
EBIT		12.1	14.1	13.1	14.4	15.9
-Depr		3.5	3.5	4.0	4.3	4.7
-Tax		3.6	4.2	3.9	4.3	4.8
+CapEx		5.0	4.5	4.0	3.7	3.3
+Chg NWC		-3.5	-8.0	-8.0	-8.0	-8.0
FCF		6.5	2.9	1.2	1.5	1.7
Terminal Value						143
DIscount Factor		.894	.775	.656	.537	.418
DCF	10.3	5.8	2.2	.8	.8	.7
Tax Shield Cash Flow Calculation
Interest Expense		2.4	2.4	2.4	2.4	2.4
Interest Tax Shield		.6	.6	.6	.6	.6
TV
Present Value Factor		.953	.873	.816	.763	.713
PV (Tax Shield)	2.5
Enterprise Value	12.8
Cash	10.0
Equity Value	22.8