07/15/2015

ANALYSIS FOR FINANCIAL MANAGEMENT

10th Edition
Robert C. Higgins
Additional Problems
Chapter 9
1. In early 2011, Amalgamated Fruit Plc was interested in acquiring Dynatech, Inc., a privately-held, electronics
company. As a first step in deciding what price to bid for Dynatech, Amalgamated's finance department has prepared a
five-year financial projection for the company assuming an acquisition. Use this projection and Dynatech's 2010 actual
financial figures to answer the questions below.
Dynatech Inc.
5-year Financial Projection
($ millions)
2010

2011

2012

2013

2014

2015

Income statement
Net sales
Cost of sales
Gross income
Depreciation
Interest expense
Operating expenses
Net income before tax
Provision for taxes
Net income after tax

243
95
148
58
19
26
45
25
39

Cash and securities

Accounts receivable
Inventory
Other current assets
Total current assets

41
25
47
18
132

Gross property and equipment

Accumulated depreciation
Net property and equipment
Goodwill
Total assets

511
102
409
129
670

612
160
452
129
678

826
284
542
129
778

991
433
559
129
812

1,051
553
498
129
772

1,093
663
430
129
708

Accounts payable
Short-term debt
Current portion long-term debt
Accrued expenses
Total current liabilities
Long-term debt
Deferred taxes

12
54
5
10
81
201
40

9
54
5
12
80
181
42

11
62
5
13
91
234
45

13
65
4
16
97
217
51

14
62
4
20
100
97
58

15
18
4
20
57
(0)
61

257
98
159
92
17
24
27
17
27

11
25
47
15
97

321
116
206
124
22
28
32
21
33

13
26
50
17
107

386
135
251
149
22
37
43
25
40

16
32
56
20
124

443
155
288
120
14
54
100
45
70

18
36
65
25
144

461
161
300
110
4
67
119
48
75

Balance sheet
19
38
67
25
149

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Shareholders' equity
Total liabilities and equity

348
670

375
678

407
778

447
812

517
772

591
708

a. Estimate Dynatech's free cash flow from 2011 through 2015.

b. Estimate the present value of Dynatech's free cash flow for the years 2011 - 2015. Amalgamated's WACC is 7.4
percent. Dynatech's WACC is 11 percent, and the average of the two companies' WACCs, weighted by sales, is 7.6
percent.
c. Estimate Dynatech's value at the end of 2010 assuming it is worth the book value of its assets at the end of 2015.
d. Based on your answer to (c) above, what is the maximum acquisition price Amalgamated should pay to acquire
Dynatech?
e. Estimate Dynatech's value at the end of 2010 assuming in the years after 2015 the company's free cash flow
grows 3 percent per year in perpetuity.
f. Based on your answer to (e) above, what is the maximum acquisition price Amalgamated should pay to acquire
Dynatech?
g. Estimate Dynatech's value at the end of 2010 assuming that at year-end 2015 the company's equity is worth 20
times earnings and its debt is worth book value.
h. Based on your answer to (g) above, what is the maximum acquisition price Amalgamated should pay to acquire
Dynatech?
i. Assuming Dynatech has 80 million shares outstanding, what maximum acquisition price per share is consistent
with each of the three estimated values of equity determined in (d), (f) and (h)?
j. Why is the value per share estimated in part (d) so much lower than the other two?
2) A multi-product company's breakup value equals the cash one could realize by splitting the company into two
or more independent firm's and disposing of each separately. A company becomes a candidate for a takeover when
its market value fall below its breakup value.
a. How might breaking up a company and selling the parts create value?
b. If the sum of the free cash flows of the enterprises created by breakup equals the cash flow of the company prior
to breakup, might breakup still create value? If so, how?
3) A women's apparel chain with a 10 percent debt-to-assets ratio and a times interest earned of 7.0 is concerned
about the possibility of losing its independence in a raid. As part of its defense management elects to sell $100
million of new debt and to repurchase some of its common stock. This will increase the debt-to-assets ratio to 60
percent and will cut times interest earned to 2.0
a. Might this restructuring reduce the company's vulnerability to a takeover? If so, how?
b. Do you think the restructuring will create value? If so, how?
c. If the tax rate is 34 percent, the interest rate is 12 percent, and the debt will be rolled-over as it matures, (i.e.,
assume the debt is outstanding in perpetuity) estimate the present value of the tax shield created by the
restructuring at a discount rate of 14 percent.

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d. Prior to the restructuring, what percentage decline in earnings before interest and taxes could the company
sustain and still cover its interest expenses? What is the comparable figure after the restructuring? If you were a
well-capitalized competitor, anxious to increase market share, what do these numbers suggest might be an
interesting strategy to use against this firm?

4) In 1980 Massey-Ferguson Ltd, a multinational producer of farm machinery, industrial machinery, and diesel engines,
lost $225 million, or $12.79 per share. This capped a three year period during which the firm lost almost half a billion
dollars. Massey-Ferguson began fiscal 1981 in default on its $2.5 billion of outstanding debt and many observers were
openly speculating that the company would soon be forced to declare bankruptcy. These problems had not escaped
notice of the stock market, which at the end of October 1980 priced the company's shares at only $5.50.
a. Calculate the market value of Massey-Ferguson's equity on October 31, 1980.
b. Assuming the market value of Massey-Ferguson's debt equals 70 percent of book value, calculate the market
value of the company on October 31, 1980. (The market value of debt is well below the $2.5 billion book value
due to the prospect of bankruptcy.)
c. Is $5.50 per share the market's estimate of the liquidation value of Massey-Fergusons equity at the end of
October? Why or why not? If not, why else would an investor buy the company's stock?
5) The following information is available about Russell Brewing Company.
Stock price
Common shares outstanding
Market value of interest-bearing debt
Weighted average cost of capital

$8 per share
10 million
$75 million
14 percent.

A private-equity company is confident that by terminating Russell's money losing fruit-flavored beer coolers and by
selling the women's hosiery division free cash flow can be increased $4 million annually for the next decade. In
addition, they estimate that an immediate, special dividend of $10 million can be financed by the sale of the hosiery
division.
a. Assuming these actions do not affect Russell's cost of capital, what is the maximum price per share the investment
company would be justified in bidding for control of Russell? What percentage premium does this represent?
b. Conduct a sensitivity analysis of your answer to (a) by assuming the cost of capital is 15 percent and the increased
cash flow is only $3.5 million per year.
6) Grubb State Power and Light's free cash flow next year will be $100 million and it is widely expected to grow at a
4 percent annual rate indefinitely. The company's weighted average cost of capital is 10 percent, the market value of
its liabilities is $1 billion, and it has 20 million shares outstanding.
a. Estimate the price per share of Grubb's common stock.
b. A private equity firm believes that by selling the company 767 airplane, increasing the work day to eight hours,
and instituting other cost savings, it can increase Grubb's free cash flow next year to $110 billion and can add a full
percentage point to Grubb's growth rate without affecting its cost of capital. What is the maximum price per share
the private equity firm can justify bidding for control of Grubb?