BW/IP International, Inc
1、BW/IP is a good candidate for the leverage buyout.
* Steady cash flow (around 30 million per year).
* Strong management team.
* Positive NPV (about 61.5 million)
The NPV of BW/IP is 61.5million(301-239.5).Thus, we are quite optimistic about this BW/IP’s project. Calculating the NPV.
Method: APV: VL=VU+PV (ITS).
We can get the interest paid schedule from the BW/IP’s projected operating performance, which means there is a pre-determined interest paid to debt holders. Assumption:
Tax rate: 38%.From 1991 to 1993, the tax rate remains to be constant, which is 38%. And we assume that the tax rate will continue to be 38%. Exhibit 1 shows the process of calculating tax rate: Growth rate:We assume the project will last for infinity, and grow in perpetuity after year 1992. And we use the average annually growth rate from 1990 to 1993 as our perpetuity growth rate, which is 2.3%. Change in NWC:We subtract cash from NWC provided in the case and we get the adjusted change in NWC. The calculation is presented in Exhibit 2. Discount rate:Typically, the investment horizon of a common leverage buyout range from 5 to 10 years, so we use the ten years treasury yields, ending at 1987 as the risk free rate, which is 8.79%.For the market return, we use the S&P 500 index in 1980s, which is 12.79%. Thus, we can easily get the risk premium. Exhibit 3 shows the process of calculating discount rate. Tax shields:Giving the interest paid schedule, we can figure out the tax shield each year from 1988 to 1993 at the tax rate of 38%. Discount rate: with a pre-determined debt and interest paid, we should use the cost of debt to get the present value of interest tax shield, because the risk of tax shield is moving together with the risk of the loan (debt), instead of the total assets. We assume the corporate borrowing rate is the same with BBB long-term bond, which is the cost of debt, 10.63%. Thus the present value of tax shield from 1988 to 1993 is 31.91.We assume perpetual debt from the year 1994, and the same growth rate, which is 2.3%. Exhibit 4 shows the processing of calculating tax shields. The FCF is presented in Exhibit 5.
Sensitivity Analysis for BW/IP is presented in Exhibit 6
2、We favor the proposed acquisition of UCP.
The primary sources of value in the transaction include:
* Low capital or cash requirement
UCP is a small firm, which would require additional borrowing by BW/IP of only 13 million. * Synergy and efficient gains.
UCP’s product line complemented BW/IP’s extremely well because UCP’s most attractive feature was its installed base in the petroleum industry and together they would have the largest installed base in the petroleum segment. * Improved management
Takeover can improve management because interest and principal payments can force management to improve performance and operating efficiency. The proposed price is reasonable, because it is higher than the levered value of the project, which is 48.17. Method: APV: VL=VU+PV (ITS).
Tax rate: Tax rate=38%, which is the same as the tax rate for BWIP. Growth rate: We use the average annually growth rate from 1991 to 1993 as ourgrowth rate,which is 6%. Discount rate: We use the ten years treasury yields, ending at 1988 as the risk free rate, which is 9.04%. Exhibit 7 shows the calculation of Vu
Exhibit 8 shows the calculation of PV(ITS)
Sensitivity Analysis for UCP/IP is presented in Exhibit 6
3. How do the various features of the BW/IP buyout affect the company’sdecisions about long-horizon opportunities such as the UCP acquisition?What are the advantages and disadvantages of the 1987 buyout, viewed as afinancial program? After the buyout, BW/IP became a privately owned company which was less dependent from Borg-Warner Corporation than before in decision making. For the opportunities that the managers favored, such as the UCP acquisition, the company...