Posted: June 14th, 2015

Week 7 Homework

Chapter 14: Exercises/Problems: #1 and #3 pp. 523 – 524

1.[DCF Valuation and Ownership Concepts] The venture investors and founders of ACE Products, a closely held corporation, are contemplating merging the successful venture into a much larger diversified firm that operates in the same industry. ACE estimates its free cash flows that will be available to the enterprise next year at $5,200,000. Since the venture is now in its maturity stage, ACE’s free cash flows are expected to continue to grow at a 6 percent annual compound growth rate in the future. A weighted average cost of capital (WACC) for the venture is estimated at 15 percent. Interest-bearing debt owed by ACE is $17.5 million. In addition, the venture has surplus cash of $4 million. ACE currently has five million shares outstanding, with three million held by venture investors and two million held by founders. The venture investors have an average investment of $2.50 per share while the founders’ average investment is $.50 per share.

A. Based on the above information, estimate the enterprise value of ACE Products. What would be the value of the venture’s equity?
B. How much of the value of ACE would belong to the venture investors versus the founders? How much would the venture be worth on a per-share basis?
C. What would be the percentage appreciation on the stock bought by the venture investors versus the investment appreciation for the founders?
D. If the founders have held their investments for five years, calculate the compound annual or internal rate of return on their investments. The venture investors made a first-round investment of 1.5 million shares at $2 per share four years ago. What was the compound annual rate of return on the first-round investment? Venture investors made a second-round investment of 1.5 million shares at $3 per share two years ago. Calculate their compound rate of return on this investment.

3.
[Relative Value Concepts Using Multiples] The WestTek privately held venture is considering the sale of the venture to an outside buyer. WestTek has net sales = $21.2 million, EBITDA = $11.1 million, net income = $2.9 million, and interest-bearing debt = million. Three publicly-traded comparable firms or competitors in the industry have the following net sales, EBITDA, net income, equity value or market capitalization (stock price times number of shares of common stock outstanding), and interest-bearing debt information:

EASTTEK SOUTHTEK NORTHTEK
Net sales $25,000,000 $37,500,000 $80,000,000
EBITDA $12,500,000 $20,000,000 $37,500,000
Net income $2,500,000 $3,000,000 $10,000,000
Equity value $45,000,000 $60,000,000 $160,000,000
Interest-bearing debt $15,000,000 $20,000,000 $40,000,000
No surplus cash is being held by WestTek or by any of the three comparable firms.
A. Calculate the enterprise value to net sales ratios for each of the three competitors (EastTek, SouthTek, and NorthTek), as well as the average ratio for the competitors.
B. Calculate the enterprise value to EBITDA ratios for each of the three competitors, as well as the average ratio for the competitors.
C. Calculate the equity value or market “cap” to net income ratios for each of the three competitors, as well as the average ratio for the competitors.
D. Estimate the enterprise and equity values for WestTek using the individual net sales multiples from EastTek, SouthTek, and NorthTek, as well as for the average of the three comparable firms. Show the valuation ranges from high to low.
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E. Estimate the enterprise and equity values for WestTek using the individual EBITDA multiples from each comparable firm, as well as the average multiple for the three competitors. Show the valuation ranges from high to low.
F. Estimate the equity values for WestTek using the individual net income multiples from each comparable firm, as well as the average multiple for the three firms.
G. Establish a range of equity value estimates for WestTek based on the highest and lowest overall values generated from the multiples analyses in Parts D, E, and F.
H. From the perspective of the selling venture investors and founders, would you recommend that they negotiate for the final selling price based on the use of top-line valuation multiples (i.e., using net sales) or bottom-line valuation multiples (i.e., using net income)?