1. (Total 14 points) Below are pro forma data for an acquiring firm and its target. Review the data and answer the questions that follow.
Exhibit 4: Pro-Formas for firm to be acquired (millions of dollars)
Sales 70 80
Cost of Goods 39.8 41.6
Gross Profit 30.2 38.4
Sell & Admin 12.3 12.4
Depreciation 2.3 2.5
EBIT 15.6 23.5
Tax @ 40% 6.24 9.4
EBIAT 9.36 14.1
Exhibit 5: Two-year forecast of the acquirer’s earnings, excluding the target (millions of dollars except per-share data)
Net Income 22.0 21.5
Shares Outstanding (mil) 6.81 6.81
Earnings per Share $3.23 $3.16
a. (4 points) The acquirer’s annual interest expense on outstanding debt was $1,000,000 in 2011. Assume this interest expense will remain the same for the next two years, and calculate the acquirer’s Net Income for 2012 and 2013.
b. (10 points) Assume that this will be a stock-for-stock deal. The acquirer’s current shareholders are concerned, however, about the deal’s potential to dilute their earnings per share. Calculate the maximum number of acquirer shares that can be offered for each target share without diluting the forecasted EPS in each of the given years (2012 and 2013).
2. (Total 49 points) It is 2001. Amanda Ling is a business valuation consultant with a degree from Lindenwood University. She has been employed by Hampton Partners (a private equity firm), which is considering the leveraged buyout of children’s clothing retailer William Carson Co. Hampton executives think Carson’s is an excellent investment: over the last five years, it has achieved strong sales growth and has successfully cut costs. While Hampton doesn’t see much more room for improvement in the cost-cutting department, they do forecast the strong sales growth to continue for the next five years. Carson’s also has a strong, experienced management team which Hampton intends to keep in place. To finance the transaction, Hampton plans to borrow $360 million for 10 years at a cost of 10.875%. The rest of the price is to be paid in stock. The deal is expected to close December 31, 2001, and the funds would be dispensed the next day.
Hampton has given Amanda the following information regarding the transaction, presented in Exhibits 1 through 4. Additionally, they project their terminal growth rate of free cash flows to be 2.5%, and the level and cost of debt achieved in 2007 to remain constant going forward. The appropriate tax rate is 38%.
Exhibit 4: Information from Comparable Companies
D/E Beta Cost of Equity
Kohl’s 0.58 1.23 15.57%
Osh Kosh 0.75 1.42 17.28%
Kids R Us 0.43 1.01 13.59%
Average 0.59 1.22 15.48%
a. (9 points) Give two reasons why Carson’s is a good LBO candidate. Give one reason why Carson’s is NOT a good LBO candidate.
b. (40 points) Amanda has performed the APV valuation of Carson’s shown on the next page. Since Amanda went to Lindenwood instead of Webster, she has gotten a few things wrong in the valuation. List her mistakes below and state how each should be corrected. Do not redo the numerical analysis.
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