Happy Times, Inc., wants to expand its party stores into the Southeast. In order
ID: 2713947 • Letter: H
Question
Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding with a market value of $230 million and a YTM of 8 percent. The company’s market capitalization is $370 million, and the required return on equity is 13 percent. Joe’s currently has debt outstanding with a market value of $35 million. The EBIT for Joe’s next year is projected to be $15.0 million. EBIT is expected to grow at 9 percent per year for the next five years before slowing to 2 percent in perpetuity. Increases in net working capital and capital spending as a percentage of EBIT are expected to be 8 percent and 14 percent, while depreciation is expected to be 7 percent of EBIT. Joe’s has 2.3 million shares outstanding and the tax rate for both companies is 30 percent.
What is the maximum share price that Happy Times should be willing to pay for Joe’s? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
After examining your analysis, the CFO of Happy Times is uncomfortable using the perpetual growth rate in cash flows. Instead, she feels that the terminal value should be estimated using the EV / EBITDA multiple. The appropriate EV / EBITDA multiple is 7.
What is your new estimate of the maximum share price for the purchase? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding with a market value of $230 million and a YTM of 8 percent. The company’s market capitalization is $370 million, and the required return on equity is 13 percent. Joe’s currently has debt outstanding with a market value of $35 million. The EBIT for Joe’s next year is projected to be $15.0 million. EBIT is expected to grow at 9 percent per year for the next five years before slowing to 2 percent in perpetuity. Increases in net working capital and capital spending as a percentage of EBIT are expected to be 8 percent and 14 percent, while depreciation is expected to be 7 percent of EBIT. Joe’s has 2.3 million shares outstanding and the tax rate for both companies is 30 percent.
Explanation / Answer
a.
To begin the valuation of Joe’s, we will begin by calculating the RWACC for Happy Times. Since both companies are in the same industry, it is likely that the RWACC for both companies will be the same. The weights of debt and equity are:
XB = $230,000,000 / ($230,000,000 + 370,000,000) = .3833, or 38.33%
XS = $370,000,000 / ($2300,000,000 + 370,000,000) = .6167, or 61.67%
The RWACC for Happy Times is:
RWACC = .3833(.08)(1 – .30) + .6167(.13) = .10163, or 10.16%
we need to calculate the cash flows for each year. The EBIT will grow at 9% per year for 5 years. Net working capital, capital spending, and depreciation are 8%, 14% and 7% of EBIT, respectively. So, the cash flows for each year over the next 5 years will be:
After Year 5 the cash flows will grow at 2 % in perpetuity. We can find the terminal value of the company in Year 5 using the cash flow in Year 6 as:
TV5 = CF6 / (RWACC – g)
TV 5 = 11.645 * (1.02) / (0.1016 – 0.02)
TV = 145.51 million
Now we can discount the cash flows and terminal value to today. Doing so, we find:
V0 = $8.25 / 1.1016 + $8.99 / (1.1016)^2 + $9.80 / (1.1016)^3
+ $10.684 / (1.1016)^4 + ($11.64 + 145.51) / (1.1016)^5
V0 = $126.36 millions
The market value of the equity is the market value of the company minus the market value of the debt, or:
S = $126.36 – 35
S = $ 91.36 millions
Now Maximum Price the Happy In. should be abe to pay is $ 91.36 Millions / no. of shares
= 91.36 Millions / 2.3
= $ 39.72 per share
b. in case the terminal value should be estimated using the EV / EBITDA multiple. The appropriate EV / EBITDA multiple is 7.
then
TV5 = CF6 x multiplier
TV 5 = 11.645 * 7
TV = 83.15 million
Now we can discount the cash flows and terminal value to today. Doing so, we find:
V0 = $8.25 / 1.1016 + $8.99 / (1.1016)^2 + $9.80 / (1.1016)^3
+ $10.684 / (1.1016)^4 + ($11.64 + 83.15) / (1.1016)^5
V0 = $87.92 millions
The market value of the equity is the market value of the company minus the market value of the debt, or:
S = $87.92 – 35
S = $ 52.92 millions
Now Maximum Price the Happy In. should be abe to pay is $ 91.36 Millions / no. of shares
= 52.92 Millions / 2.3
= $ 23.01 per share
Year 1 Year 2 Year 3 Year 4 Year 5 EBIT 15.00 16.35 17.82 19.43 21.17 Less :Taxes @ 30% -4.50 -4.91 -5.35 -5.83 -6.35 Net Income 10.50 11.45 12.48 13.60 14.82 Add :Depreciation @ 7% of EBIT 1.05 1.14 1.25 1.36 1.48 Operating Cash flow 11.55 12.59 13.72 14.96 16.30 Less. Net Working Capital change @ 8% -1.20 -1.31 -1.43 -1.55 -1.69 Less. Capital spending @ 14% -2.10 -2.29 -2.50 -2.72 -2.96 Free Cash flow 8.25 8.99 9.80 10.68 11.65Related Questions
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