Happy Times, Inc., wants to expand its party stores into the Southeast. In order
ID: 2765646 • Letter: H
Question
Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding with a market value of $230 million and a YTM of 10 percent. The company’s market capitalization is $290 million, and the required return on equity is 15 percent. Joe’s currently has debt outstanding with a market value of $27 million. The EBIT for Joe’s next year is projected to be $17.0 million. EBIT is expected to grow at 9 percent per year for the next five years before slowing to 2 percent in perpetuity. Increases in net working capital and capital spending as a percentage of EBIT are expected to be 8 percent and 14 percent, while depreciation is expected to be 7 percent of EBIT. Joe’s has 2.05 million shares outstanding and the tax rate for both companies is 30 percent.
What is the maximum share price that Happy Times should be willing to pay for Joe’s?
After examining your analysis, the CFO of Happy Times is uncomfortable using the perpetual growth rate in cash flows. Instead, she feels that the terminal value should be estimated using the EV / EBITDA multiple. The appropriate EV / EBITDA multiple is 9.
What is your new estimate of the maximum share price for the purchase?
After examining your analysis, the CFO of Happy Times is uncomfortable using the perpetual growth rate in cash flows. Instead, she feels that the terminal value should be estimated using the EV / EBITDA multiple. The appropriate EV / EBITDA multiple is 9.
Explanation / Answer
a. Explanation:-
To start with Joe's valuation, we need to calculate kWACC of Happy Times, Inc because the both companies are in same industry it is likely that KWACC of both company is likely to be same. Calculation for weight of Debt and Equity are as follows:
WD= $230Million/$230 million +$290million= 0.4423
WE = $290million//$230 million +$290million= 0.5577
KWACC of Happy Times Inc. is
KWACC= KD(1-tax) *WD +KE*WE
=0.4423*0.10(1-0.3)+0.5577*0.15
=0.030961+0.083655
=0.114616 or 11.46%
Now we requiured to calculate cashflow of each year .EBIT is expected to grow at 9 percent per year for the next five years before slowing to 2 percent in perpetuity. Increases in net working capital ,capital spending and depreciation are expected to be as a percentage of EBIT 8 percent, 14 percent, 7 percent respectively.
After 5 year cashflow will grow at 2% for perpetuity. We need to find terminal value of year 5 cashflow using year 6 cashflow as follows
TV5 = TV6 /KWACC-g
= $13.1983(1.02) /0.1146-0.02
=$13.4623/0.0946
=$142.3076
Now we can discount the all cashflow to find out present value.
The value of Equity is Total value of Company less Value of Debt = $122.8565 - $27 = $95.8565 million
Maximum share price that Happy Times should be willing to pay for Joe’s is = $95.8565 million/2.05 million shares outstanding = $46.76
b.To find out terminal value using the EV / EBITDA multiple we need to calculate year 5 EBITDA which is EBIT +Depreciation
Now we can calculate year 5 terminal valu using the EV / EBITDA multiple
=$25.6767*9 =$231.09
Now we need to calculate present value of all cashflow 1 to 5 year. Year 5 Terminal value $231.09 includes cash flow of 5th year so we need not to take it again.
The value of Equity is Total value of Company less Value of Debt = $166.7941 - $27 = $139.7941 million
Maximum share price that Happy Times should be willing to pay for Joe’s is = $139.7941 million/2.05 million shares outstanding = $68.19
$ million Year1 Year 2 Year3 Year 4 Year 5 EBIT 17.0000 18.5300 20.1977 22.0155 23.9969 Taxes 5.1000 5.5590 6.0593 6.6046 7.1991 Net Income 11.9000 12.9710 14.1384 15.4108 16.7978 Depreciation 7% of EBIT 1.1900 1.2971 1.4138 1.5411 1.6798 OCF 13.0900 14.2681 15.5522 16.9519 18.4776 Capital Spending 14% of EBIT 2.3800 2.5942 2.8277 3.0822 3.3596 Change in NWC 8% of EBIT 1.3600 1.4824 1.6158 1.7612 1.9198 Cashflow from asset 9.3500 10.1915 11.1087 12.1085 13.1983Related Questions
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