ZSC would spin-off its fast-growing customer application software business. ZSC developed this software to service its existing distribution clients in the late 1990s. However, the versatility of the software appealed to companies in other industries, and ZSC began to operate software as a small separate business (Software). After the spin-off, stockholders will have two stock certificates ZSC and Software.

Spinoff Idea Software (No Repurchase)

A. What is the likely market price per share (50 million shares) for the software business? Use DCF and Comparable Companies techniques as set forth in Value Method X and Y.

B. Value Method X: Discounted Free Cash Flow - 5 years forecast, (Dec. 31, 2020 to Dec. 31, 2025)

a. What is the approximate equity-cost-of-capital (discount rate) for Software to use in the DCF valuation?

b. What are your free-cash-flow forecasts for Software? Briefly explain your forecast assumptions.

c. What is the proper terminal value (or sales price for Software) on 12/31/2025 for the DCF valuation? (You should look at the comparable firms attributes, make any judgments for whether Software is better or worse than the comparable firms, and estimate the EV/EBITDA ratio for Software terminal value in 2025.)

d. For the equity-cost-of-capital of Software, consider the Hamada equation and the two comparable stocks. Seek Week 6 slides and Week 7 slides.

C. Value Method Y: Comparable Companies - EV/EBITDA ratio at Dec. 31, 2020.

a. Consider the two comparable software stocks.

b. Should the Software business have the same or different value ratio?

c. Estimate the proper EV/EBITDA ratio for Software, and Softwares stock price after a spinoff on December 31, 2020

Exhibit 1: Information on ZSC stock at December 31, 2020

Exchange:	NYSE
EPS (2020):	$3.20
Growth Rate:	6%
Cost of Equity:	11% (historically)
Stock Price:	$44.00
P/E Ratio:	13.8x
Beta:	1.1
Cost of Debt	5%

Exhibit 2: ZSC Balance Sheet (US$ Millions)

	12/31/2019	12/31/2020
Cash	$0	$0
Other Current Assets	800	865
Total Current Assets	800	865
Net Property & Plant	820	840
Other Assets	125	125
	$1,745	$1,830
Current Liabilities	$415	$430
Long-term Debt	0	0
Stockholders Equity	1,330	1,400
	$1,745	$1,830

Exhibit 3: ZSC Income Statement (US$ Millions) (Except per share)

	Year Ending
	12/31/19	12/31/20
Revenue (1)	$1,900	$2,000
EBITDA	$300	$340
Depreciation & Amort (2)	(100)	(110)
EBIT	200	230
Interest	0	0
Pre-tax Profit	200	230
Taxes (30%)(3)	(60)	(70)
Net Income	$140	$160
Earnings Per Share	$2.80	$3.20
Shares Outstanding	50.0	50.0

(1) Revenue growth has ranged between 2% and 4% the last five years for the distribution business, but growth has been higher for Software. ZSC forecasts Distribution business growth at 2% for 2021.

(2) EBITDA/Revenues ratio has ranged from 14% to 18%.

(3) Tax rate is stable at 30%.

Exhibit 4: ZSC Statement of Cash Flows

	Year Ending
	12/31/2020
Operations
Net Income	$160
Depreciation & Amort.	110
	270
Changes in Working Capital
Current Assets	$(65)
Current Liabilities	25
	(40)
Cash Flow from Operations	$230
Investments
Capital Expenditures (1)	$(140)
Financing
Borrowing and Debt Repay.	0
Stock Repurchase	0
Financing, net	0
Cash Flow Available for Dividends	90
Dividends Paid	(90)
Change in Cash	$0

(1) Capital expenditures for the distribution business have averaged $100-130 million per year. The software operations capex was $10-15 million per year.

Exhibit 5: Summary Results Software

ZSC has not supplied Rhodes with full information on its software business. For 2021, growth will higher for software than the distribution business.

Software Balance Sheet US$ Millions (12/31/2020)
Cash	$0
Other Current Assets	20
	$20
Net Property & Plant	70
Other Assets	10
	$100
Current Liabilities	$12
Long-Term Debt	0
Equity	88
	$100

Software Income Statement (US$ Millions)

Exhibit 7: Comparable Public Companies

Computer Supply Distributors (12/31/2020)

	P/E	EV/EBITDA	Growth Rate	Equity Beta	D/E Ratio
Devor Supply	16.0X	7.2X	9%	1.3	30/70
Catane Supply	15.0X	6.6X	8%	1.2	20/50

Devon and Catane can be compared to ZSC before and after spin-off or repurchase.

Customer Service Software Firms (12/31/2020)

	P/E	EV/EBITDA	Growth Rate	Equity Beta	D/E Ratio
Merit Software	22.0X	15.0X	14%	1.4x	20/80
J-10 Software	23.0X	16.2X	18%	1.6x	10/90

Risk-free rate = 3%

Market risk premium (MRP) = 6%

All tax rates = 30%

Use CAPM for calculating cost-of-equity

Use Hamada equation for adjustments to cost of equity