Problem 1. [DCF Valuation and Ownership Concepts] The venture investors and founders of the ACE Products venture, a closely held corporation, are contemplating merging the successful venture into a much larger diversified firm that operates in the same industry. ACE estimates its free cash flows that will be available to the enterprise next year at $5,200,000. Since the venture is now in its maturity stage, ACE's free cash flows are expected to continue to grow at a 6 percent annual compound growth rate in the future. A weighted average cost of capital (WACC) for the venture is estimated at 15 percent. Interest-bearing debt owed by ACE is $17.5 million. In addition, the venture also has surplus cash of $4 million. ACE currently has 5 million shares outstanding with 3 million held by venture investors and 2 million held by founders. The venture investors have an average investment of $2.50 per share while the founders' average investment is $.50 per share.
A. Based on the above information, estimate the enterprise value of ACE Products. What would be the value of the venture's equity?
B. How much of the value of ACE would belong to the venture investors versus the founders. How much would the venture be worth on a per share basis?
C. What would be the percentage appreciation on the stock bought by the venture investors versus the investment appreciation for the founders?
D. If the founders have held their investments for five years, calculate their compound annual or internal rate of return on their investments. The venture investors made a first round investment of 1.5 million shares at $2 per share four years ago. What was the compound annual rate of return on the first round investment? Venture investors made a second round investment of 1.5 million shares at $3 per share two years ago. Calculate their compound rate of return on this investment.
Problem 2. [Acquisition Valuation Concepts] The BETA firm is proposing to acquire the ACE Products venture described in Problem 1. BETA estimates that ACE's free cash flow for next year could be improved to $5.5 million because of synergistic benefits in the form of operating or distribution economies. The potential acquirer also believes that ACE's perpetuity growth rate could be increased to 7 percent annually. However, the riskiness of the cash flows would be increased causing the appropriate WACC to increase to 16 percent. Interest-bearing debt owed by ACE is $17.5 million. In addition, the venture also has surplus cash of $4 million. ACE Products has five million shares of common stock outstanding.
A. Determine ACE's enterprise value from the perspective of BETA. What is ACE's equity worth to BETA in dollar amount and on a per share basis?
B. Use the per share value of ACE from Problem 1 and the per share value from this problem and establish a range of values (i.e., without and with expected synergistic benefits). If one-half of the synergy derived benefits were allocated to ACE's venture investors and founders, what price per share would the merger take place?
C. BETA has thirty million shares of stock outstanding with a market capitalization value of $600 million. What is BETA's stock price? Determine the exchange ratio between ACE's stock value and BETA's stock price at each of ACE's values established in Part B. That is, what would ACE's venture investors and founders receive in BETA's shares for each share of common stock they currently hold in ACE Products?
Problem 3. [Relative Value Concepts Using Multiples] The WestTek privately held venture is considering the sale of the venture to an outside buyer. WestTek has net sales = $21.2 million, EBITDA = $11.1 million, net income = $2.9 million, and interest-bearing debt = $12 million. Three publicly-traded comparable firms or competitors in the industry have the following net sales, EBITDA, net income, equity value or market capitalization (stock price times number of shares of common stock outstanding), and interest-bearing debt information:
EastTek SouthTek NorthTek
Net sales $25,000,000 $37,500,000 $80,000,000
EBITDA 12,500,000 20,000,000 37,500,000
Net Income 2,500,000 3,000,000 10,000,000
Equity Value 45,000,000 60,000,000 160,000,000
Interest-bearing 15,000,000 20,000,000 40,000,000
Debt
No surplus cash is being held by WestTek or by any of the three comparable firms.
A. Calculate the enterprise value to net sales ratios for each of the three competitors (EastTek, SouthTek, and NorthTek), as well as the average ratio for the competitors.
B. Calculate the enterprise value to EBITDA ratios for each of the three competitors, as well as the average ratio for the competitors.
C. Calculate the equity value or market "cap" to net income ratios for each of the three competitors, as well as the average ratio for the competitors.
D. Estimate the enterprise and equity values for WestTek using the individual net sales multiples from EastTek, SouthTek, and NorthTek, as well as for the average of the three competitors or comparable firms. Show the valuation ranges from high to low.
E. Estimate the enterprise and equity values for WestTek using the individual EBITDA multiples from each comparable firm, as well as the average multiple for the three competitors. Show the valuation ranges from high to low.
F. Estimate the equity values for WestTek using the individual net income multiples from each comparable firm, as well as the average multiple for the three firms.
G. Establish a range of equity value estimates for WestTek based on the highest and lowest overall values generated from the multiples analyses in Parts D, E, and F. Also establish a range of market value estimates for WestTek based on the highest and lowest average values from the multiples analyses in Parts D, E, and F.
H. From the perspective of the selling venture investors and founders, would you recommend that they negotiate for the final selling price be based on the use of top-line valuation multiples (i.e., using net sales) or bottom-line valuation multiples (i.e., using net income)?