1. Background-
Frank Johnson is 55 years of age. Over twenty years ago Frank and his brother, John, founded Johnson Adhesives, Inc. (the Company). The Johnson family has always owned the business. Frank and John own 55% and 35% of the common stock in the Company, respectively. A cousin owns the remaining 10% interest; he also works for the Company.
Johnson Adhesives manufacturers adhesives and sealants and has annual revenues of approximately $50 million. It has six manufacturing locations throughout the U.S. Frank and John are both active in daily management and in making all major decisions. Frank has a MBA degree. John has never attended college. They both have extensive experience with the Company's products and in all aspects of the operations.
Frank and his wife, Susan, have been married for 25 years and are in the process of getting a divorce. Susan's divorce attorney hired your boss, Maria, on behalf of his client to be an expert in the matrimonial litigation between Frank and Susan. Maria is a CPA specializing in forensic accounting and valuation.
Frank made a ?nancial o?er to Susan in an attempt to quickly settle the divorce. Frank hired Valuations R Us to value his 55% equity interest in Johnson Adhesives. That ?rm has completed its work and issued a report. The value of Frank's shares-as estimated by Valuations R Us-was used by Frank in making the settlement o?er. Frank's shares are a marital asset under state law and, accordingly, the value of the shares is a component of the total marital net worth. In addition, Frank and Susan live in a state that uses fair market value as the standard of value in divorce matters. Further, the divorce law in their state says that fair market value is the same de?nition as used by the Internal Revenue Service.
Susan has told her attorney that the Company was writing o? personal expenses of Frank and John (to lower taxable income and, therefore, income taxes) and both received large bonuses from the business. Susan was able to provide her attorney with the following information about the Company:1
- Personal expenses such as vacations, meals and entertainment, country club dues, and personal automobile expenses of $500,000 per year.
- The operating expenses of a private jet of $1 million per year and the jet is used for personal trips 50% of the jet's usage.
- The compensation paid to Frank and John was $750,000 per year each.
- In 2011, the Company paid $1 million to settle a lawsuit brought by a former employee for an injury su?ered while on the job.
Maria has also learned the following. Johnson Adhesives previously ?led an election with the U.S. Internal Revenue Service to be treated as an S-Corporation. Accordingly, the corporation does not pay income taxes. Rather, the Company's income is allocated among the shareholders who then report their portion of the business's income on their personal income tax returns and pay taxes. In addition, Frank and John are both in good health and expect to work for at least another 10 years.
Susan's divorce attorney sent a copy of valuation report prepared by Valuations R Us to your boss. You only can tell what Valuations R Us did by reading their report as you do not have an opportunity to talk with them about their report.
Valuations R Us did not know this information because they did not perform any forensic accounting on the Company's ?nancial statements and Frank Johnson did not disclose this information to them.
Your boss has asked you to value Frank's stock as of December 31, 2013. Because of the circumstances, you do not have an opportunity to interview Frank Johnson or anyone else in management.
Maria has provided you (1) the report of Valuations R Us plus Excel ?le containing Exhibit 2 to their report, (2) selected data from Valuation Handbook: Guide to Cost of Capital, 2014 edition published by Du? & Phelps and (3) a report on the industry (which you are to assume is valid as of the valuation date). In addition, she has provided you the following information:
- The Company's net income is the same as its net cash ?ow.
- The CAPM 'beta' of a large public company (BigCo) that submitted an o?er to buy Johnson Adhesives one year ago is 1.1.
- The median price multiples of ?ve public companies that are most comparable to Johnson Adhesives are shown in Table 1. (Note: Maria has instructed you to use these price multiples for your analysis and not to search for any other market multiples.)
Table 1: Median price multiples
Market value of invested capital to sales 0.54
Market value of invested capital to EBITDA 5.80
Market value of invested capital to EBIT 7.26
Market value of equity to pre-tax income 6.72
2- Assignment
You are a staff member at Maria's ?rm. Maria is a CPA specializing in forensic accounting and valuation. Maria has assigned you to perform this project. Your will analyze information and then submit a written report. Your analysis and report should comply with generally accepted professional standards for business valuations. The scope of your work is to estimate the fair market value of Frank Johnson's 55% interest in the Company as of December 31, 2013 for marital dissolution purposes.
Your report should cite each source of information that you use in your analysis. In addition, your report should include an industry analysis, economic analysis, and ?nancial statement analysis as well as the other appropriate parts described in professional standards. Further, use at least one reasonableness test to assist you in completing this assignment.
Hint: Finding data often takes longer than initially expected. Identify and collect your data early. You will need to collect information for at least the following areas: your industry analysis, economic analysis, ?nancial statement analysis, and cost of capital analysis. As noted, you are not to collect sales transaction data on your own.
Attachment:- Assignment.rar