Question
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
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 |
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Canadian Income Taxation Planning And Decision Making
Authors: Joan Kitunen, William Buckwold
17th Edition 2014-2015 Version
1259094332, 978-1259094330
