EUROPEAN AUDIO-VISUALS, LTD.

European Audio-visuals, Ltd.1

European Audio-visuals,Ltd. is a company based in Barcelona specialized in producing and
marketing contents through videotapes and cd-roms.
During the last years, European Audio-visuals, Ltd. has increased its market share and is
one of the companies in the industry with the highest sales growth rate.

Financial plan for the next five years

According to the general manager forecasts, the company will continue with a high growth
rate during the next years (see Appendix).
During the last years, the industry has experienced a very favourable economic
environment, but for the next years economists doesn’t agree and some of them predict
recession and are more pessimistic about the future in this industry.

The offer to buy the company

Two months ago, the main competitor of European Audio-visuals,Ltd. passed an offer to
buy all the share capital of the firm after revising the financial plan (Appendix).
According to the potential buyers, this financial plan is optimistic because they believe that
the company can have a net profit of just 137 monetary units (m.u.) per year.
The two companies agreed that an auditing company and a legal consulting firm would
prepare the due diligence process.
Some days ago, the due diligence process has finished with the following conclusions:

-According to the auditors the accounts of the firm provide a true and fair view of
the financial and economic situation in the year 0 but they propose an adjustment
related to bad debts (increasing the bad debts provission by 20 m.u.).
-The report of the legal consulting firm concludes that there are not material
contingencies in connection with tax and other legal matters.

The potential buyer2 offered yesterday two alternatives to the shareholders of European
Audio-visuals, Ltd.:

-Alternative I: 1.050 m.u. (650 when signing the contract, 200 m.u. 90 days later
and 200 m.u. 180 days after signing the contract).

-Alternative II: A maximum price of 1.200 m.u. to be paid as follows:

• 650 m.u. when signing the contract, 125 m.u. 90 days after signing the
contract and 125 m.u. 180 days after signing the contract.
• 100 m.u. if the profit of year 1 reaches the budget (included in the financial
plan of Appendix 1). The formula applied will be:

100 m.u. - (Budget of Net Profit year 1 – Real Net Profit year 1)

• 200 m.u. if the profit of year 2 reaches the budget (included in the financial
plan of Appendix 1).

1
Case written by Oriol Amat, Departament of Economics and Business, Universitat Pompeu Fabra. Version
2006.
2
The opportunity cost is 10% per year while the interest risk-free is 5,5%.

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 EUROPEAN AUDIO-VISUALS, LTD.

The last two payments would be paid after the audit of the accounts for years 1 and 2. The
amounts to be paid will have an increase based in the Euribor3 + 0,75.
Another condition of the buyer is that the general manager of European Audio-visuals, Ltd.
must continue in the company for some years.

Questions:

1-Identify the strenghts and weaknesses of the firm from a financial and economic point of
view.

2-What is your opinion about the financial plan for the next years.

3-How much is the value of the firm?

4-What is your opinion about the two alternatives offered by the buyer?

5-What would you recommend to the shareholders of European Audio-visuals, Ltd.?

3
Average Euribor daily from the previous month.

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 EUROPEAN AUDIO-VISUALS, LTD.

European Audio-visuals, Ltd. Balance sheets (m.u.)

Industry4
-4 -3 -2 -1 0 Avg. Ideal
-- -- -- -- ------- ----- -----
Assets % % %

Fixed assets5 18 69 65 84 93 15 26 23

Inventories6 42 38 29 85 120 20 18 20
Trade debtors 39 83 117 147 259
Other debtors 6 7 11 25 42
Short term financial
investments 51 58 50 49
Cash 2 10 12 17 46 7 6 8
-----------------------------------------------------------
Current assets 89 138 169 274 518 85 74 77
-----------------------------------------------------------
Total assets 107 207 234 358 611 100 100 100

Capital 32 32 32 32 32
Reserves 23 33 60 77 142
Net profit 10 35 55 75 160
-----------------------------------------------------------
Equity 65 100 147 184 334 55 45 47

Long term debt 6 45 33 14 5 1 13 8

Trade creditors 31 42 32 128 214

Other creditors 3 8 10 28 55
Bank loans 0 12 12 4 3
-----------------------------------------------------------
Current liabilities 38 62 54 160 272 44 42 45

Total equity & liab. 107 207 234 358 611 100 100 100

4
Amat, O. et al (2000): “Ratios sectoriales”, KPMG, Gestión 2000, Barcelona.
5
Fair value of fixed assets is 30 higher.
6
Fair value of inventories is 50 higher.

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European Audio-visuals, Ltd.. Profit and loss accounts (m.u.

and percentages for year 0)
Industry (%)
------------
-4 -3 -2 -1 0 Avg. Ideal
--- --- --- --- ------- ----- -----
Sales 314 408 425 461 679 100 100 100
Cost of sales 189 246 234 195 262 39 45 46
--------------------------------------------- ----- -----
Gross margin 125 162 190 266 417 61 55 54

Overhead 99 127 139 167 190 28 43,5 43

Depreciation 6 6 6 6 6 1 4,6 3,7
--------------------------------------------- ----- -----
EBIT 20 29 46 93 221 32 6,9 7,3
Financial income 1 1 1 1 4 1 5 3
Financial expenses 7 5 3 3 2 0 3 1
--------------------------------------------- ----- -----
EBT 14 25 44 91 223 31 8,9 9,3
Income Tax 3 5 3 16 63 8 1,8 1,7
--------------------------------------------- ----- -----
Net profit 11 20 41 75 160 23 7,1 7,6

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European Audio-visuals, Ltd. Ratios

Industry
-----------
-4 -3 -2 -1 0 Avg. Ideal
--- --- --- --- --- ----- -----
Current assets/Current liab. 2,3 2,2 3,1 1,7 1,9 1,8 1,7

Debts /Equity + Debt 0,4 0,5 0,4 0,5 0,45 0,53 0,51

Sales / Assets 2,9 1,9 1,8 1,3 1,1 0,84 0,96

Sales / Fixed assets 17 5,9 6,5 5,4 7,3 3,28 4,14

Stock days 81 56 45 159 167 174 167

Customers days 45 74 100 116 139 155 138

Suppliers days 60 62 50 239 298 147 147

ROS (Net profit/Sales)*100 3,5 4,9 9,6 16 23 7,1 7,6

ROI (EBIT / Assets)*100 18 14 20 26 36 5 7

ROE (Net profit/Equity)*100 17 31 41 51 87 15 18

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Financial plan for the years 1 to 5 for European Audio-visuals, Ltd

Hypotesis to prepare the plan:

-Investments: Every year an investment of 2 m.u. in fixed assets will be needed.

-Sales: The budget includes a sales increase of 15% every year.
-Expenses: It is forecasted an increase of 15% for year 1 and increases of 5% for the rest of
the years. Depreciation will be similar to previous years. Income tax will be 30% of EBT.
The company will not have financial expenses and financial income will grow every year.
-Working capital management: The days of trade receivables, stocks and trade payables
will be similar to previous years.

The forecast for the profit and loss accounts of year 1 to 5 is as follows:

1 2 3 4 5
------ ------ ------ ------ ------
Sales 790 908 998 1099 1209
Cost of sales 331 381 419 463 508
---------------------------------------------------------------------------
Gross margin 459 527 579 637 701
Overhead 218 229 241 252 265
Depreciation 6 6 6 6 6
----------------------------------------------------------------------------
EBIT 235 292 332 379 430
Interest income 0 +2 +4 +6 +8
-----------------------------------------------------------------------------
EBT 235 294 334 385 438
Income tax 70 88 101 116 131
-----------------------------------------------------------------------------
Net profit 165 206 235 269 307

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The net profit evolution is as follows:

Prior years Forecast

-------------------------------- -----------------------------------------
-3 -2 -1 0 1 2 2 3 4
----- ------- -------- ------- ------- ------- ------ ------ ------
Net profit 20 41 75 160 165 206 235 269 307
Net profit increase 100% 85% 116% 3% 24% 28% 14% 14%

The free cash flow forecast is as follows:

1 2 3 4 5 Total
------ ------ ------ ------ ------ ------
Net profit 165 206 235 269 307 1182
Depreciation +6 +6 +6 +6 +6
--------------------------------------------------------------------------------
Cash flow 171 212 241 275 313
-Fixed assets investments -2 -2 -2 -2 -2
-Stocks increase -18 -20 -22 -24 -26
-Trade receivables increase -39 -44 -49 -54 -59
+Trade payables increase +32 +34 +36 +38 +40
--------------------------------------------------------------------------------
Free cash flow +144 +180 +204 +233 +266 +1027