Problemset - Assignment #2 Valuing a the Target...

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Unformatted text preview: Assignment #2 Valuing a the Target Company of a Corporate Takeover A large food conglomerate is seeking to acquire a well ­established company in the confectionary (candy) industry. The CFO of the acquiring company is considering using your investment ­banking team, among others, to underwrite the acquisition. You will be hired based on how well your valuation corroborates the CFO’s independent analysis (i.e., my analysis). Because the CFO understands that there is inherent uncertainty in the valuation process, he has asked that you provide a confidence interval with your valuation: a lower and upper bound outside of which you think a valuation should be rejected. You will win the job if you satisfy the following criteria: 1. The CFO’s valuation falls within your confidence interval. If it is outside your acceptable region, then you will not be hired. 2. The difference between the CFO’s valuation and yours, plus the width of your confidence interval, is the lowest among all competing investment banks. 3. The analysis supporting your valuation and confidence interval is well motivated and free of analytical error. To illustrate how this works, assume that your valuation is $1 billion +/ ­ $100 million and the CFO’s independent valuation is $950 million. Because the CFO’s valuation falls within your confidence interval, criterion 1 is satisfied. You will win the business if your combined valuation difference and confidence interval (i.e., $1 billion  ­ $950 million + 2*$100 million = $250 million) is lowest among all competitors, and your analysis is without material error. Your project grade will not be determined by winning the competition, but on how well you perform and present your analysis. To receive high marks, your analysis must not only be of high quality, but your write ­up must be clear, concise, and easy to follow. That is, the quality of your writing is important. Your write ­up should be no more than five pages, including all supporting information and tables. No exceptions. The report should begin with an executive summary that clearly states (1) your valuation in dollars, (2) your confidence interval in dollars, and (3) any key assumptions or conclusions that you want to highlight. The body of the report should describe the details of your analysis and should follow the valuation steps outlined below. Please make sure that your report is well formatted and that all of your key assumptions and findings are well articulated/described. Background • The acquiring company is a food conglomerate with multiple lines of business in the food industry. • The target company is a candy ­maker and leading producer of desserts, ice cream, chocolates, cakes, and other sugar treats. The company spun off its beverage unit a year earlier (roughly half of its operation), making the company a mono ­line business. • The acquiring company would like to make this mono ­line business a new division of its conglomerate. The CFO thinks that a successful deal will require the acquirer to pay for the target company by issuing equal proportions of debt and equity. That is, the acquiring company will (1) assume the debt of the target, (2) issue new debt, and (3) exchange its shares for the target company’s shares such that the sum of 1 and 2 equals 3. Financial data Your research team (me) has already assembled the necessary financial data. They are contained in two separate excel files. The first contains balance sheet and income statement data for the acquiring company, target company, and twelve companies in the food industry that may be relevant for your analysis. The second file contains five years of monthly returns for all of the companies in the first file, the 3 ­month T ­bill rate, and three market indices. The first index is the S&P500. The second is an equal ­weighted index of all publicly traded companies. The third is a value ­weighted index of all publicly traded companies The twelve “comparable” companies listed below are drawn from the following standard industrial classification (SIC) codes: 2050 (cookies and crackers), 2060 (sugar and confectionary products), and 2090 (miscellaneous food preparations and kindred). You are not required to use all twelve companies in your analysis, but if you don’t, you must state why. Also, although there may be other relevant companies not included here, there is no need to identify them or otherwise use them in the analysis. Company ACQUIRING COMPANY TARGET COMPANY Ticker CANADA BREAD CO LTD ($CA) DIAMOND FOODS INC HERSHEY CO IMPERIAL SUGAR CO INVENTURE FOODS INC MEDIFAST INC ROCKY MOUNTAIN CHOC FACT SNYDERS-LANCE INC TASTY BAKING CO TATE & LYLE PLC TOOTSIE ROLL INDUSTRIES INC WRIGLEY (WM) JR CO CBY DMND HSY IPSU SNAK MED RMCF LNCE TSTY TATYY TR WWY Assets ($millions) 63,078 13,004 Sales ($millions) 42,201 7,871 Market value ($millions) 39,451 12,065 995 273 3,635 359 65 51 17 466 159 5,719 812 5,232 1,708 531 5,133 592 113 105 29 852 174 4,686 496 5,389 1,201 394 7,887 162 30 79 35 723 28 1,713 1,407 16,123 Required Analysis Use a weighted average cost of capital approach to valuing the targeted confectionary company. To do this, you will need to determine (1) the cost of debt and equity required to finance the acquisition and (2) the future stream of unlevered cash flows that the target company is likely to produce for the conglomerate once it is a division. Your valuation will be the investment that makes this cash flow return a zero NPV. Your confidence interval should be based on a sensitivity analysis. The factors and assumptions in your sensitivity analysis are entirely up to you. However, explain your choices. Note: be careful not to over complicate this analysis. Sometimes, simple is better if your focus is well justified. Cost of equity: use the CAPM. You will need to choose a risk free rate, beta, and market risk premium. • For the risk free rate, use the three ­month T ­bill. • Use an industry beta based on your set of comparable companies. Be sure to delever the betas before averaging. Re ­lever beta according to the capital structure you envision that the merged companies will have (i.e., predict the new capital structure of the acquirer after the deal is completed). • Choose what you think is an appropriate market risk premium. Justify your choice. Comment: consider discussing why using industry comparables is better than using the target or acquiring firm’s cost of equity. Cost of debt: use the acquirer company’s borrowing rate. Recall that the acquiring company will finance half of the purchase with the issuance of new debt. This will change the acquiring company’s capital structure and may lower its credit rating (and thus increase borrowing cost). You must decide how to account for this (i.e., financing side effect). WACC: Once you have calculated the cost of equity and debt, determine the WACC based on the projected capital structure of the combined companies. That is, use the capital structure that you think the acquiring firm will have once the deal is completed. Unlevered cash flows: Calculate the unlevered cash flows for the firm in each of the five years leading up to the acquisition. Think carefully about what goes into this number and clearly state how you arrived at it. Use these cash flows and any other supporting data to make your assessment of the ongoing cash flow stream. In this assessment, consider whether: • the cash flows will grow, stay steady, or decline. • profit margins will remain as they are • there will be synergies (benefits) from being part of a conglomerate • the conglomerate will stifle the business Each of these considerations could provide the basis for a sensitivity analysis. Feel free to explore any other factors or assumptions that may affect your assessment of future cash flows. Valuation: Find the investment that makes your cash flows realize a zero NPV. Perform a sensitivity analysis to establish an upper and lower bound outside of which you think a valuation is unreasonable. Calculate the acquisition price that corresponds to your valuation. Recall that your valuation is for both the outstanding debt and equity of the target company. Hence, to get the share price you will need to take your valuation, subtract the target company’s outstanding debt, and divide by the number of common stock shares outstanding. How does this price compare to the last year ­end stock price contained in the excel file? Appendix – variable descriptions Variable gvkey year month return vwretd ewretd sprtrn rf ticker company currency current_assets accounts_payable total_assets book_equity cash cash_and_equivalent cogs shares_outstanding debt_convertible debt_longterm depreciation dividends ebit ebitda goodwill intangible_assets inventories current_liabilities total_liabilities net_income pretax_income PPE preferred_stock receivables total_revenue sales taxes working_capital extraordinary_itemss interest_expense stock_price Units % % % % % $ millions $ millions $ millions $ millions $ millions $ millions $ millions millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ millions $ Description Global Company Key calendar year relative to the acquisition year calendar month company return (monthly) value weighted index of all public firms equal weighted index of all public firms S&P500 index risk free rate - 3 month tbill Ticker Symbol Company Name ISO Currency Code Current Assets - Total Accounts Payable - Trade Assets - Total Common/Ordinary Equity - Total Cash Cash and Short-Term Investments Cost of Goods Sold Common Shares Outstanding Debt - Convertible Long-Term Debt - Total Depreciation and Amortization Dividends - Total Earnings Before Interest and Taxes Earnings Before Interest Goodwill Intangible Assets - Total Inventories - Total Current Liabilities - Total Liabilities - Total Net Income (Loss) Pretax Income Property, Plant and Equipment - Total Preferred Stock - Redemption Value Receivables - Total Revenue - Total Sales/Turnover (Net) Income Taxes - Total Working Capital (Balance Sheet) Extraordinary Items Interest and Related Expense - Total Price Close - Annual - Fiscal ...
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