Happy Times, Inc., wants to expand its party stores into the Southeast. In order
ID: 2822120 • 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 $110 million and a YTM of 5 percent. The company's market capitalization is $330 million, and the required return on equity is 10 percent. Joe's currently has debt outstanding with a market value of $29 million. The EBIT for Joe's next year is projected to be $12 million. EBIT is expected to grow at 9 percent per year for the next five years before slowing to 2 percent in perpetuity. Net working capital, capital spending, and depreciation as a percentage of EBIT are expected to be 8 percent, 14 percent, and 7 percent respectively. Joe's has 1.85 million shares outstanding and the tax rate for both companies is 30 percent. a. What is the maximum share price that Happy Times should be willing to pay for Joe's? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Maximum share price 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 b. What is your new estimate of the maximum share price for the purchase? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Maximum share price $ |Explanation / Answer
(A)Valuation of Joe Company using Free Cash Flow Approach:-
Free Cash Flow for Firm = NOPAT – [Capital Spending + Changes in Working Capital – Depreciation]
NOPAT = EBIT * (1-Tax Rate)
Important Note;- In the question, Net working Capital is given as % of EBIT. We need the change in Working Capital. So, we assume the opening working capital for First year to be NIL.
The language mentioned in questioned can in no way be treated as change in working Capital
Calculation of Free Cash Flow for the First 5 years
Years
EBIT
NOPAT
W.C
Change in W.C
C.S
Deprn
FCFF
PV @ 10%
1
12.0000
8.4000
0.9600
0.9600
1.6800
0.8400
6.6000
6.00
2
13.0800
9.1560
1.0464
0.0864
1.8312
0.9156
8.1540
6.74
3
14.2572
9.9800
1.1406
0.0942
1.9960
0.9980
8.8878
6.68
4
15.5403
10.878
1.2432
0.1026
2.1756
1.0878
9.6878
6.62
5
16.9390
11.857
1.3551
0.1119
2.3715
1.1857
10.559
6.56
32.60
Calculation for 6th Year
EBIT = 16.9390*1.02 = 17.2778
NOPAT= 12.0944
Working Cap = 1.3822
So, Change in WC= 1.3822-1.3551=0.0271
Capital Spending = 2.4189
Depreciation = 1.2094
FCFF of 6th year= 10.86 I.E TERMINAL VALUE
PV OF FCFF = {[10.86/(0.1-.02)]/(1.1)5} = 84.27
Value of Joe firm = 32.60+84.27 = 116.87
Market Value of Debt = 29
So, Value of Equity = $ M 87.87
No. of Shares= M 1.85
So, Maximum Price per share that Happy would Pay = 87.87/1.85 = $ 47.50 per share
(B) EBIDTA for 6th year = 17.2778+ 1.2094 = $M 18.4872
EBIDTA Multiple = 9
= 166.38
Terminal Value = 166.38
PV Of terminal Value = 93.91
SAHRE PRICE = (32.6+93.91)/1.85= $ 68.38 per share
Years
EBIT
NOPAT
W.C
Change in W.C
C.S
Deprn
FCFF
PV @ 10%
1
12.0000
8.4000
0.9600
0.9600
1.6800
0.8400
6.6000
6.00
2
13.0800
9.1560
1.0464
0.0864
1.8312
0.9156
8.1540
6.74
3
14.2572
9.9800
1.1406
0.0942
1.9960
0.9980
8.8878
6.68
4
15.5403
10.878
1.2432
0.1026
2.1756
1.0878
9.6878
6.62
5
16.9390
11.857
1.3551
0.1119
2.3715
1.1857
10.559
6.56
32.60
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.