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Executive Summary
Newell Manufacturing & Design (NMD) was started 40 years ago as a small family firm selling
DIY tools and materials at trade shows and through its mail order catalog. The company made
great strides during the economic boom of 90s but failed to maintain its run rate later amidst
economic slowdown and changing retail landscape. Economic slowdown and financial
constraints forced the management, now run under leadership of Sarah Newell, to run operations
on a conservative basis with virtually nil debt. Sarah believes that it is a probable time now to
sell the company since it is out of woods and is making stable profits. She has been approached
by Esteban Armijo, a California entrepreneur running a private equity fund, who is interested in
buying either entire NMD or any of its division. Sarah is seeking an advice as to whether to sell
the entire organization or to sell any one division and is interested in understanding the value at
which she should put the offer in front of Esteban. Also she is interested in knowing that if she
sell only Mail Order Division and continue with the remaining till her retirement in 2019, will
she be in a position to sell subsequently or take the division public through IPO in 2019. Our
study recommends that Sarah should sell the Mail Order Division with a minimum value of $173
million. Also it is advisable to retain the Manufacturing Division, given higher expectation of
growth, and grow it until 2019 and then either sell it or take it public through IPO to monetize
the value which will be worth at least $955.8 million in 2019.

Cases Under Evaluation

Our study is based on evaluation of following alternatives:
1. If Sarah considers selling entire NMD as a single unit then what should be the minimum
value that she should demand from Esteban
2. What should be her asking rate if she decides to sell only Mail Order Division
3. What should be the value of Manufacturing Division if she decides to sell it or what
should be the value in 2019 at which she should consider selling it or taking it public
through IPO
Basis the valuations in above three cases, we based our final decision to Sarah.
Assumptions to Analysis
Before we move to main analysis, there are few assumptions that have been considered for
applying to valuation logic across all three cases. These are:
NMD is a debt free company and hence free cash flow to equity is free cash flow to firm
NMD has come out of investment cycle and need no incremental capital expenditure
The working capital need is very short term and met by line of credit which is paid off
immediately and hence remains no outstanding at end of the year
It is assumed that the company maintain its working capital at same level and hence there
is no change in working capital
Terminal Growth for Newell Design (Mail Order) division is given as 9% and for Newell
Manufacturing division is given as 10% beyond 2019 onwards. In case of overall
organization the same is taken at an average of explicit forecast period which is at 7%
Peer set in case of Mail Order Division has been considered by taking only such entities
which have mailing list of upward of 3 million households and rests are ignored. Peer set
in case of Newell Manufacturing Division has been considered by taking all entities
highlighted under Light Industrial category. For overall firm, all entities are considered

Cost of Equity of NMD

Given that cost of equity was not available readily for NMD, as it is a private company, the same
has been derived using industry averages.
Three different cost of equity has been derived viz. for the overall firm, for mail order division
and for manufacturing division to evaluate each of the above three highlighted alternatives.
Average industry betas, average industry leverage ratios and average industry tax rates have been
taken under each of the three options based on respective peer set. The point that needs to be
noted here is that the average industry beta under each case is a levered beta. Given that NMD is
a debt-free company, we had to derive the unlevered beta using HAMADA Equation so as to
make use of CAPM model to arrive at respective cost of equity for each case. (Pablo Fernandez,
2003)
 Industry Metric Overall MailOrder Industrial
Average Levered Beta 1.41 1.22 1.65
Average Leverage 0.33 0.20 0.40
Average Tax Rate 20% 14% 22%

Unlevered Beta
HAMADA EQUATION
Levered beta / [1+(1-Tax rate) * Debt / Equity] 1.01 1.00 1.09
Market Return (Rm) 10.00% 10.00% 10.00%
Risk-free rate (Rf) 3.00% 3.00% 3.00%

Cost of Equity
CAPM
Rf + Beta * (RM - Rf) 10.08% 10.03% 10.61%

Valuation
For valuing each alternative, free cash flow to equity (FCFE) has been derived. In the given case,
in absence of debt, free cash to equity is also equal to free cash flow to firm. (Aswath
Damodaran, Chapter 14)
Free Cash Flow to Equity = Net Income + Depreciation New Capital Expenditure Change
in Working Capital.
Terminal Value = FCFE in 2019 * (1 + constant growth rate) / (Cost of Equity Constant
Growth)
The above cash flow is then discounted to derive the Firm / Division Value as on today. Value in
2019 is represented by the terminal value. As per Sarah, the firm or divisions are expected to
grow at a steady rate beyond 2019.
Using above the fair value has been derived for each case. Industry data has been used to derive
the average premium paid over the fair value in case of acquisitions happened in the past under
each case in the respective industry. Minimum target price has been derived by topping fair value
with the average premium.
Valuation of overall NMD
Year 0 1 2 3 4 5 6
Annual Growth 7.4% 6.3% 7.4% 6.4% 5.9% 7.8%
Net Income 5,213,572 5,552,789 6,343,979 7,217,496 7,718,735 6,299,187
Add: Depreciation 1,784,496 1,838,031 1,927,334 1,985,154 2,044,709 2,163,132
Less: New Capex - - - - - -
Less: Change in Working Capital - - - - - -
Free Cash Flow to Equity 6,998,068 7,390,820 8,271,313 9,202,650 9,763,444 8,462,319
Terminal Value @ 7% growth 293,542,761
Free Cash Flow to Equity and Terminal Growth 6,998,068 7,390,820 8,271,313 9,202,650 9,763,444 302,005,080
Discounting Factor 0.9084 0.8252 0.7496 0.6809 0.6185 0.5619
Overall Firm Value 200,650,309
Value of Firm in 2019 293,542,761
Fair Value of Firm NMD today is $200.6 million and value in 2019 is $293.5 million
Valuation of NMDs Mail Order Division
Year 0 1 2 3 4 5 6
Annual Growth 9.0% 9.0% 9.0% 9.0% 8.0% 9.0%
Net Income 1,534,274 2,039,082 2,432,240 2,657,993 3,004,178 2,209,790
Add: Depreciation 126,146 129,930 133,828 137,843 141,978 146,238
Less: New Capex - - - - - -
Less: Change in Working Capital - - - - - -
Free Cash Flow to Equity 1,660,420 2,169,012 2,566,068 2,795,836 3,146,156 2,356,028
Terminal Value @ 9% growth 250,418,115
Free Cash Flow to Equity and Terminal Growth 1,660,420 2,169,012 2,566,068 2,795,836 3,146,156 252,774,143
Discounting Factor 0.9089 0.8261 0.7508 0.6824 0.6202 0.5637
Overall Division Value 151,572,543
Division Value in 2019 250,418,115

Fair Value of NMDs Mail Order Division today is $151.6 million and value in 2019 is $250.4
million.
Valuation of NMDs Manufacturing Division
Year 0 1 2 3 4 5 6
Annual Growth 5.0% 3.0% 5.0% 3.0% 3.0% 6.0%
Net Income 3,055,161 2,884,052 3,028,634 3,209,526 3,051,016 2,785,364
Add: Depreciation 1,658,350 1,708,101 1,793,506 1,847,311 1,902,730 2,016,894
Less: New Capex - - - - - -
Less: Change in Working Capital - - - - - -
Free Cash Flow to Equity 4,713,511 4,592,153 4,822,140 5,056,837 4,953,746 4,802,258
Terminal Value @ 10% growth 867,892,323
Free Cash Flow to Equity and Terminal Growth 4,713,511 4,592,153 4,822,140 5,056,837 4,953,746 872,694,581
Discounting Factor 0.9041 0.8174 0.7390 0.6681 0.6040 0.5461
Overall Division Value 494,520,040
Value of Division in 2019 867,892,323

Fair Value of NMDs Manufacturing Division today is $494.5 million and value in 2019 is
$867.9 million.
Target Value under each alternative
Whenever acquisition has happened, the average premium paid over fair market value in case of
overall industry is 12%, 14% in case of mail order division and 10% in case of manufacturing
division.
 Fair Value Today in 2019
Overall Firm Value 200,650,309 293,542,761

Target Value (incl premium) Today in 2019

Overall Firm Value 224,276,883 328,107,422

Fair Value Today in 2019

Value of Mail Order Division 151,572,543 250,418,115
Value of Manufacturing Division 494,520,040 867,892,323

Target Value (incl premium) Today in 2019

Value of Mail Order Division 172,540,078 285,059,288
Value of Manufacturing Division 544,590,194 955,766,420

Recommendation
Based on our analysis, the value of overall NMD today is $224.3 million based on consolidated
financials. However the value of Mail Order Division and Manufacturing Division at $172.5
million and $544.6 million respectively combined together is considerably higher than the
overall value of the firm.
Our overall study recommends that Sarah should sell the Mail Order Division with a minimum
value of $173 million. This division will make a strategic fit for Estaben and hence he will
always great interest in buying it by paying a suitable premium. Also since Sarah believes that
the recently started manufacturing division has potential to turn into major wholesale
manufacturer and will be benefitted by recently announced bankruptcy of a national retail
electronics parts supplier, it is advisable to retain this unit and grow it until 2019 and then either
sell it or take it public through IPO to monetize the value which will be worth at least $955.8
million in 2019. Given the underlying value of manufacturing division, it is not advisable to sell
the entire firm to Estaben unless he is ready to pay the minimum combined price of both the
division which should be at least $717 million.

Risks attached to our recommendation

The entire value of NMD either overall or at division level is derived primarily from Terminal
Value (82% in case of overall firm, 93% in case of mail order division and 95% in case of
manufacturing division). This is a highly risky proposition. The reason behind such skew
towards terminal value is Sarahs expectation of steady growth in the business at 7%, 9% and
10% respectively beyond 2019 and cost of equity at 10.08%, 10.03% and 10.61% respectively.
The derived valuation is commanding much high a multiple over sales when compared to
industry average and this may not be acceptable by Estaben. However NMDs net margin either
at overall or at division level is significantly higher than the industry and such delta in margin on
top of steady high growth should command much higher premium and hence justifies the rich
valuation.
Fair Value Today in 2019 Value to Sales Multiple Industry average Margins NMD Industry
Overall Firm Value 200,650,309 293,542,761 2.92 0.95 Overall 8.4% 4.9%
Mail Order 6.6% 2.7%
Target Value (incl premium) Today in 2019 Manufacturing 9.2% 5.7%
Overall Firm Value 224,276,883 328,107,422 3.26 0.95

Fair Value Today in 2019

Value of Mail Order Division 151,572,543 250,418,115 4.16 0.78
Value of Manufacturing Division 494,520,040 867,892,323 15.66 0.89

Target Value (incl premium) Today in 2019

Value of Mail Order Division 172,540,078 285,059,288 4.73 0.78
Value of Manufacturing Division 544,590,194 955,766,420 17.24 0.89
References

1. Pablo Fernandez, 2003, Levered and Unlevered Beta

http://www.iese.edu/research/pdfs/DI-0488-E.pdf

2. Aswath Damodaran, Chapter 14, Free Cash Flow to Equity Discount Models

http://people.stern.nyu.edu/adamodar/pdfiles/valn2ed/ch14.pdf