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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
SNYDERSLANCE 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 ShortTerm Investments
Cost of Goods Sold
Common Shares Outstanding
Debt  Convertible
LongTerm 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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 Fall '11
 WilliamHandorf
 Corporate Finance

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