In summer 2015, Smidgeon Industries was evaluating whether to purchase one of it
ID: 2776518 • Letter: I
Question
In summer 2015, Smidgeon Industries was evaluating whether to purchase one of its suppliers. The supplier, Carswell Manufacturing, provides Smidgeon with the raw steel Smidgeon uses to fabricate utility trailers. One of the first things that Smidgeon's managers did was to forecast the cash flows of Carswell for the next five years:
Next, Smidgeon's management team looked at a group of similar firms and estimated Carswell's cost of capital to be 15%. Finally, the team estimated that Carswell would be worth approximately six times its year 5 cash flow in five years.
A. What is your estimate of the enterprise value of Carswell?
B. What is the value of the equity of Carswell if the acquisition goes through, and Smidgeon borrows $2.4 million and finances the remainder using equity?
Year Cash Flows 1 $ 1,200,000 2 1,260,000 3 1,323,000 4 1,389,150 5 1,458,608Explanation / Answer
Cost of capital = 15% Year Cash Flows Discount factor Discounted cash flow 1 1200000 1.15 1043478.261 2 1260000 1.3225 952741.0208 3 1323000 1.520875 869893.9755 4 1389150 1.74900625 794251.0211 5 1458608 2.011357188 725185.9635 6 6 times cash flow in year 5 8751648 2.313060766 3783578.94 Enterprise value= Sum of discounted CF= 8169129.182 Discount factor= (1 + cost of capital) ^ corresponding period Discounted cash flow = =Cash flow/discount factor Borrowed amount= 2400000 Value of equity= Enterprise value - debt 5769129.182
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