Question

Problem 1 (15 points) Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an mediate 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 &$105 million and a YIM of 6 percent. The company's market capitalization is $285 million and the required return on equity is 11 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 $12.6 million. EBIT is expected to grow at 10 percent per year for the next five years before slowing to 3 percent in perpetuity. Net working capital, capital spending, and depreciation as a percentage of EBIT are expected to be 9 percent, 15 percent, and 8 percent, respectively. Joe's has 1.95 million shares outstanding and the tax rate for both companies is 38 percent a. Based on these estimates, what is the maximum share price that Happy Times should be willing to pay for Joe's? (9 points) b. 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. If the appropriate EV/EBITDA multiple is 8, what is your new estimate of the maximum share price for the purchase? (6 points)

Answer 1

Q.a Based on the information given in the questions, maximum price can be offered to Joe is $60.73 per Share outstanding. Detail calculation is presented below :

All figures are in Million $

Time in years	T0	T1	T2	T3	T4	T5	T6
EBIT	$12.60	$13.86	$15.25	$16.77	$18.45	$20.29	$20.90
Tax @385	$4.79	$5.27	$5.79	$6.37	$7.01	$7.71	$7.94
EAT	$7.81	$8.59	$9.45	$10.40	$11.44	$12.58	$12.96
Depreciation - 8% of EBIT	$1.01	$1.11	$1.22	$1.34	$1.48	$1.62	$1.67
Capital Sepnding - -15% of EBIT	($1.89)	($2.08)	($2.29)	($2.52)	($2.77)	($3.04)	($3.14)
Working Capital - 9% of EBIT	($1.13)	($1.25)	($1.37)	($1.51)	($1.66)	($1.83)	($1.88)
Net Cash Inflow		$6.38	$7.01	$7.71	$8.49	$9.33	$9.61
Outstanding Debt	($30.00)
Equity cost - 11%
Present Value	$1.000	$0.901	$0.812	$0.731	$0.659	$0.596
PV of Cash Flow	($30.00)	$5.74	$5.69	$5.64	$5.59	$5.56	$120.18
NPV	$118.42
No of Shares outstanding in Million	1.95
Price to be offered per share	$60.73

Please note that 6th year onwards the growth in EBIT will be 3% in perpetuity. so the PV of cash flow from 6th year onwards is calculated with the formula PV of Cash flow = Cash flow in 6th year / (Rate of Interest - Rate of Growth)

= $9.61 Million / (0.11 - 0.03) = $120.18 million.

Q.b

EV/EBITDA multiple = 8

Calculation of Terminal Value using EV/EBITDA multiple = Present EBITDA X 8

= ($12.60 + $ 1.01)million X 8

= $13.61 million X 8

= $ 108.86 million

Therefore maximum share price can be offered = $108.86 million / 1.95 million = $40.44 per share