CASE STUDY HOMEWORK CORPORATE FINANCE
PROFESSOR: G. BERTINETTI
STUDENT Albert Maurer
The Situation: In 2010 a new company was created in order to enter into the food industry. They spent many months in studying the market, engineering the products and the commercial strategy, find out the production plants. At the end of 2010 the business plan is ready and the company has already participated to an exhibition where many potential customers said to be very interested to the project. The problem: A private equity institution gets in touch with the company in order to buy 30% of the company buying new shares. The company wonders about the value of such shares, that is why the company asks a consultant to provide an estimation. The business idea: To manufacture in Italy, thanks to the well-known reliable partners, in order to maintain high quality. This way the company will be the leader in the market. To create franchising shops, in order to develop the brand and the customers' loyalty. To let franchisee pay weekly only the final goods he has already sold. This way: The company knows the daily amount of sales and also the product mix. Moreover it becomes easier to modify the production and to minimize the stock. Cash-inflows get closer, while the working capital investment becomes lower with a lower customer credit risk. Financial forecast: The business plan has been developed looking at an exhaustive market analysis. Forecast data are reliable; they refer to the first five years. The target is to open 80 franchising shops within five years. Indeed, is that the optimal minimum number of shops in order to achieve the optimal minimal production output. The questions: 1) Which is the fair cost of capital for the company? 2) Which is the price to ask to the private equity company for 30% of shares of the company?
Considerations: We downloaded most of the data from the "stern1" website. The Financial Forecast data was given to us by our professor. In the forecast "EBITDA" was twice times mentioned, we assumed for our further calculations that the first "EBITDA" is the "EBIT" Furthermore with the "EBIT", we calculated the depreciation. However, for our DCF (Discounted Cash Flow) Valuation, the data of the year 2010 is not necessary. With reference to our BBB rated American bond, we discounted it, on an assumption that the valuation was done by February 2011. In particular we thought about starting from the first quarter of the year, which leads to a value of 0.75 of maturity for our first discounted Cash-flow. The remaining ones could be taken from the calculation table at the end of this report. The present value, is the value of a private company, it is calculated by discounting the cashflows. The discounted rate reflects the risk in a firm and the debt. The company itself wants to sell 30% of their shares to a private equity investor. Present Value calculation:
WACC (Weighted Cost of Average) Before we are able to calculate the fair value of the firm, we have to consider several components. For calculating the WACC, we have to consider three main components: a) cost of equity, b) cost of debt and c) capital structure. Cost of Capital: It is sometimes called, in an economic context, discount rate. The cost of capital is a market driven number. That is the reason why we use market value weights. In particular it is the expected rate of return that the market requires in order to attract funds to an investment. It is often called as opportunity costs. Being more precise it means that an investor will not invest in a particular asset if there is a more attractive substitute. Cost of Capital = Cost of Equity (E/(D+E)) + After-tax Cost of Debt (D/(D+E)) Cost of Debt: It is the cost of debt financing to company, when the company takes out a loan or issues a bond. It depends on risk factors. It is calculated by: 1
Cost of debt=Risk free...
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