Professor: LUIS A. PIAZZON, PH.D
Cooper Industries, Inc.
CASE: COOPER INDUSTRIES, INC.
Following are the answers to the case:
1. If you were Mr. Cizik of Cooper Industries, would you try to gain control of Nicholson File Company in May 1972?
We have taken the flowing steps for this analysis:
* Determine the value of the Nicholson File Company as a whole. For this we have calculated the NPV. * Determined the value of Nicholson on a synergy, assuming after it has been acquired by Coopers. * Determine the value of Cooper Industries on after the synergy. We have calculated the new NPV for this step. * Evaluated the acquisition strategies based on the above calculations and the financial position of Cooper.
Calculation of WACC
The cost of equity was determined using Damodaran to obtain the risk free rate, market premium and the unlevered β (For Cooper we used Heavy Truck and Equip Makers Industry and for Nicholson we used Metal Fabricating industry). See exhibit 1 * Cost of capital of Cooper: 19.10%
* Cost of capital of Nicholson: 18.24%
In order to calculate the cost of debt we divided the Interest Expense by the Long Term Debt. We got the following results: * Cost of Debt for Cooper = 8.8%
* Cost of Debt for Nicholson = 6.7%
Finally we have used these inputs to obtain the WACC for each company (see exhibit 2): * WACC for Cooper: 16.01%
* WACC Nicholson: 14.27%
* Note that we have assumed a stable firm model
Determining the value of the Nicholson File Company as a whole
We have forecasted the value of Nicholson assuming a stable growth form model under three growth scenarios, 2%, 4% and 6%. The capital expenditure has been assumed equal to the depreciation charged. This has been done to keep a constant productive capacity for the firm. The net change in working capital has been calculated under the assumption that the working capital requirements change in the same proportion as sales. See exhibit 3. Next is the scenario analysis:
Determining the value of Nicholson on a synergy
COGS will reduce from 69% to 65%, and the SGA expenses will reduce from 22% to 19%. The projected Income Statement for Nicholson after taking into account the synergies are in exhibit 4.
Determining the value of Cooper Industries on after the synergy
Taking the numbers from 1971 will yield biased results, thus we have calculated the averages over 5 years for Cooper. We have forecasted the value of Cooper assuming a stable growth form model under three growth scenarios, 2%, 4%, 6%. The capital expenditure has been assumed equal to the depreciation charged. This has been done to keep a constant productive capacity for the firm. The net change in working capital has been calculated under the assumption that the working capital requirements change in the same proportion as sales. See exhibit 5.
The current fair price of Nicholson assuming the current 2% growth continues is $21.00. In case we take an optimistic view of 6% growth, the Nicholson's stock price goes up to $32.38. Moreover, if Cooper decided to merger with Nicholson, because of the synergy, it would be worth $76.30 at a growth rate of 6%. Even if Nicholson's growth is 2%, it is still worth $49.23 to Cooper. Furthermore this gives access to a large distribution channel to Cooper and a diverse mix of customers. This industry also satisfies the criteria that have been set for acquisitions by Cooper. Thus, Cooper should definitely bid for Nicholson and the maximum bid should be $60.13 per share.
2. What is the maximum Price that Cooper can afford to pay for Nicholson and till keeps the acquisition attractive from the standpoint of cooper? (Treasury bills yielded 5.6% in May 1972)
The maximum price that Cooper can afford to pay for Nicholson should be $60.13 per share for the reasons...