Happy Times, Inc., wants to expand its party stores into the Southeast. In order

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 $130 million and a YTM of 10 percent. The company’s market capitalization is $350 million, and the required return on equity is 15 percent. Joe’s currently has debt outstanding with a market value of $30 million. The EBIT for Joe’s next year is projected to be $17 million. EBIT is expected to grow at 7 percent per year for the next five years before slowing to 5 percent in perpetuity. Net working capital, capital spending, and depreciation as a percentage of EBIT are expected to be 6 percent, 12 percent, and 5 percent, respectively. Joe’s has 2.3 million shares outstanding, and the tax rate for both companies is 35 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 9.

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).)

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).)

Explanation / Answer

WACC of Happy Times Type of capital Mkt. value Proportion Cost Prop.*Cost Debt 130 0.371429 0.1 0.037143 Equity 220 0.628571 0.15 0.094286 Total 350 1 0.131429 WACC   0.131429 Values for JOE Year EBIT Tax @ 35% EAT Add Back Depn.5%*EBIT Less: NWC 6%*EBIT Less:Capital expre.12%*EBIT Annual FCFF to equity holders PV F @ 13.14% WACC PV @ 13.14% 1 17 17 5.95 11.05 0.85 1.02 2.04 8.84 0.88386 7.813329 2 17*1.07^1= 18.19 6.3665 11.8235 0.9095 1.0914 2.1828 9.4588 0.78121 7.389307 3 17*1.07^2= 19.4633 6.812155 12.65115 0.973165 1.167798 2.335596 10.12092 0.69048 6.988296 4 17*1.07^3= 20.8257 7.289006 13.53673 1.041287 1.249544 2.499088 10.82938 0.61029 6.609048 5 17*1.07^4= 22.2835 7.799236 14.4843 1.114177 1.337012 2.674024 11.58744 0.53941 6.250381 6 17*1.07^5= 23.8434 8.345183 15.4982 1.192169 1.430603 2.861206 12.39856 0.47676 5.911179 6 ((17*1.07^5)*(1+0.05))/(0.15-0.05)= 250.355484 87.62442 162.7311 12.51777 15.02133 30.04266 130.1849 0.47676 62.06738 Present value of Joe"s Equity 103.0289 Maximum share price that Happy Times should be willing to pay for Joe’s   = Value of equity 103.0289 million Market Value of Debt 30 million Total value of fim 133.0289 million Maximum share price that Happy Times should be willing to pay for Joe’s   = 133.0289 million Using EV/EBITDA mulitple 9 to calculate terminal value Year EBIT Tax @ 35% EAT Add Back Depn.5%*EBIT Less: NWC 6%*EBIT Less:Capital expre.12%*EBIT Annual FCFF to equity holders PV F @ 13.14% WACC PV @ 13.14% 1 17 17 5.95 11.05 0.85 1.02 2.04 8.84 0.88386 7.813329 2 17*1.07^1= 18.19 6.3665 11.8235 0.9095 1.0914 2.1828 9.4588 0.78121 7.389307 3 17*1.07^2= 19.4633 6.812155 12.65115 0.973165 1.167798 2.335596 10.12092 0.69048 6.988296 4 17*1.07^3= 20.8257 7.289006 13.53673 1.041287 1.249544 2.499088 10.82938 0.61029 6.609048 5 17*1.07^4= 22.2835 7.799236 14.4843 1.114177 1.337012 2.674024 11.58744 0.53941 6.250381 6 17*1.07^5= 23.8434 8.345183 15.4982 1.192169 1.430603 2.861206 12.39856 0.47676 5.911179 6 ((17*1.07^5)*(1+0.05)*9 225.319936 78.86198 146.458 11.266 13.5192 27.03839 117.1664 0.47676 55.86064 Present value of Joe"s Equity 96.82218 Maximum share price that Happy Times should be willing to pay for Joe’s   = Value of equity 96.82218 million Market Value of Debt 30 million Total value of fim 126.8222 million Maximum share price that Happy Times should be willing to pay for Joe’s   = 126.8222 million

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