Statement of the Problem

In January 2013, Sterling Household Products Company (Sterling), a highly successful manufacturer and marketer of household goods, was experiencing low growth rates for unit volume, sales, and profits which led management to seek expansion into higher growth industries. Between 2010 and 2012, sales had a compounded annual growth rate (CAGR) of only 2.2%, sales volumes in units were less than 1% per year, operating expenses rising faster than inflation, and retailers with high buying power (The 10 largest customers accounted for 55% of sales). Sterling identified the health care infection-control market as an attractive sector with high growth opportunities, and the product lines were a natural extension of Sterling’s current production. Sterling found its ideal investment opportunity through Montagne Medical Instruments Company’s (Montagne) germicidal, sanitation, and antiseptic products unit (GS&A Unit). The unit was profitable with an operating margin of 18.9% in 2012 and sales grew over 5% annually the past two years. However it was not a core focus for Montagne and required scarce resources and time, so Montagne was eager to sell the unit. The acquisition also provided an option to expand capacity (current full capacity will be reached in 2014) for $60 million and generate additional sales of 20% base sales in 2014, 30% in 2015, and 40% thereafter. The two companies tentatively agreed on a cash offer of $265 million. However, a discounted cash flow (DCF) analysis of the base acquisition and option will be performed along with a strategic and sensitivity analysis to help Sterling determine the value of the acquisition, the expansion option, and in combination. Sterling must ultimately decide whether to pursue the acquisition either with or without the option, retract its offer, or renegotiate the terms.

Discussion
Weighted Average Cost of Capital (WACC) Calculation Cost of Equity (COE) Cost of Debt (COD)

The

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