Question

Abbott Inc. is deciding whether or not to purchase Costello Corp. Costello has the following financial information

Costello Corp
Income Statement
Revenues		$15,000,000
Cost of Goods Sold		$8,500,000
Gross Profit		$6,500,000
Operating Expenses
SG&A Expense		$3,250,000
Depreciation Expense		$1,650,000
Advertising Expense		$320,000
Shipping Expenses		$170,000
Operating Profit		$1,110,000
Interest Expense		$650,000
Income before Taxes		$460,000
Income Tax Expense		$115,000
Net Income		$345,000

Costello’s debts of $1,500,000 will be paid off at the end of year 5 resulting in no interest payments thereafter. In addition, Abbott knows that the equipment will need repairs and expect to pay $500,000 for repairs in Year 2 and another $750,000 in Year 4.  

Regarding the business performance, Abbott believes that they can increase revenues by 9% per year for the first three years, after which it will plateau at 3% growth per year. They believe COGS will increase by 12% during each of the first 2 years and then only go up 2% per year afterward. However, to achieve this goal they will increase ad spending to $500,000 in the first year and then keep that same dollar amount in ad spending thereafter. Depreciation will be consistent throughout the foreseeable future. SG&A and Shipping expenses will both grow by 3% per year. Costello’s income tax rate is 25%. Abbott only wishes to forecast cash flows 8 years out as they believe there is too much uncertainty thereafter.

Abbott has a desired rate of return of at least 9% on any investments they make. Determine whether Abbott should acquire Costello Corp for the price of $8,500,000.

Answer 1

It should be noted that revenue is increase by 9 % for first 3 years and then 3 % thereafter.
Gross margin is increase for 43.33% to 48 %.

Advetisement is increased by 25% in first year and same thereafter.

SG&A and Shipping expense increase by 4% every year.