dati - should be their minimum asking price from the...

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P5-23. Dean and Edwards Inc. (D&E) is a firm that provides temporary employees to businesses. D&E’s client base has grown rapidly in recent years, and the firm has been quite profitable. The firm’s co-founders, Mr. Dean and Mr. Edwards, believe in a conservative approach to financial man- agement and therefore have not borrowed any money to finance their business. A larger company in the industry has approach D&E about buying them out. In the most recent year, 2006, D&E generated free cash flow of $1.4 million. Suppose that D&E projects that these cash flows will grow at 15 percent per year for the next four years, and then will settle down to a long-run growth rate of 7 percent per year. The cofounders want a 14 percent return on their investment. What
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Unformatted text preview: should be their minimum asking price from the potential acquirer? Answer: The free cash flow forecasts look like this: 2007 $1,610,000 (up 15%) 2008 $1,851,500 (up 15%) 2009 $2,129,225 (up 15%) 2010 $2,448,609 (up 15%) 2011 $2,620,011 (up 7%) Use the variable growth model to calculate the present value of the stream and you obtain a total enterprise value of $27,884,704 = 1,610,000 / 1.14 + 1,851,500 / 1.14^2+ 2,129,225 /1.14^3+ 2,448,609 / 1.14^4 + 1/ 1.14^4 2,620,211 / .14 -.07 Because there is no debt or preferred stock, this is the value of the equity. At this price, the cofounders earn a 14 percent return on their investment, so this should be their minimum asking price....
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This note was uploaded on 08/26/2011 for the course ECON 515 taught by Professor John during the Spring '11 term at American University of Kuwait.

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