Question

Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding with a market value of $150 million and a YTM of 5 percent. The company’s market capitalization is $390 million, and the required return on equity is 10 percent. Joe’s currently has debt outstanding with a market value of $31 million. The EBIT for Joe’s next year is projected to be $12 million. EBIT is expected to grow at 9 percent per year for the next five years before slowing to 2 percent in perpetuity. Net working capital, capital spending, and depreciation as a percentage of EBIT are expected to be 8 percent, 14 percent, and 7 percent, respectively. Joe’s has 1.9 million shares outstanding, and the tax rate for both companies is 30 percent.

a. What is the maximum share price that Happy Times should be willing to pay for Joe’s? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Maximum share price

After examining your analysis, the CFO of Happy Times is uncomfortable using the perpetual growth rate in cash flows. Instead, she feels that the terminal value should be estimated using the EV/EBITDA multiple. The appropriate EV/EBITDA multiple is 9.

b. What is your new estimate of the maximum share price for the purchase? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Maximum share price           $

Answer 1

A1	B	C	D	E	F	G	H	I	J	K	L	M	N
2	2/19/2017
3	2
4		For Happy Time Inc.
5		Tax Rate	30%
6		Debt market Value	$150	million
7		YTM	5%
8		Market Value of equity	$390	million
9		Required return on equity	10%
10		Total market value	$540	million
11		W(D)	0.28
12		W(E)	0.72
13		WACC	8.19%
14
15		For Joe's Party Supply
16		debt market value	$31	million
17		EBIT next year	$12	million
18		EBIT Growth Rate (5 Years)	9%
19		Terminal (Growth rate)	2%
20		Net working capital	8%
21		Capital Spending	14%
22		Depreciation	7%
23		Tax rate	30%
24		a)
25		Year	0	1	2	3	4	5	6	7	8	…
26		EBIT		$12.00	$13.08	$14.26	$15.54	$16.94	$18.46	$18.83	$19.21	$19.59
27		Depreciation		$0.84	$0.92	$1.00	$1.09	$1.19	$1.29	$1.32	$1.34	$1.37
28		Operating Cash Flow		$9.24	$10.07	$10.98	$11.97	$13.04	$14.22	$14.50	$14.79	$15.09
29		Capital Spending		$1.68	$1.83	$2.00	$2.18	$2.37	$2.58	$2.64	$2.69	$2.74
30		Net Working Capital		$0.96	$1.05	$1.14	$1.24	$1.36	$1.48	$1.51	$1.54	$1.57
31		Free cash flow		$6.60	$7.19	$7.84	$8.55	$9.32	$10.15	$10.36	$10.57	$10.78
32		Growth Rate			9%	9%	9%	9%	9%	2%	2%	2%
33		Terminal Value							167.2146
34		Present Value of Cash Flows		$6.10	$6.15	$6.19	$6.24	$6.28	$110.57
35		Value of the company	$141.53	million
36		Value of debt	$31	million
37		Value of equity	$110.53	million
38		Number of shares outstanding	1.9	million
39		Maximum Share Price	$55.27
40
41		b)
42		EBIT next Year	$12	million
43		Depreciation Next Year	$0.84	million
44		EBITDA	$12.84	million
45		EV/EBITDA	9
46		EV	$115.56	million
47		Value of debt	$31	million
48		Value of equity	$84.56	million
49		Number of shares outstanding	1.9	million
50		Maximum Price per share	$44.51	million
51
52

Formula sheet

A1

B

C

D

E

F

G

H

I

J

K

L

M

N

2

42785

3

2

4

For Happy Time Inc.

5

Tax Rate

0.3

6

Debt market Value

150

million

7

YTM

0.05

8

Market Value of equity

390

million

9

Required return on equity

0.1

10

Total market value

=D8+D6

million

11

W(D)

=D6/D10

12

W(E)

=D8/D10

13

WACC

=D11*D7*(1-D5)+D12*D9

14

15

For Joe's Party Supply

16

debt market value

31

million

17

EBIT next year

12

million

18

EBIT Growth Rate (5 Years)

0.09

19

Terminal (Growth rate)

0.02

20

Net working capital

0.08

21

Capital Spending

0.14

22

Depreciation

0.07

23

Tax rate

0.3

24

a)

25

Year

0

=D25+1

=E25+1

=F25+1

=G25+1

=H25+1

=I25+1

=J25+1

=K25+1

…

26

EBIT

=D17

=E26*(1+$D$18)

=F26*(1+$D$18)

=G26*(1+$D$18)

=H26*(1+$D$18)

=I26*(1+$D$18)

=J26*(1+2%)

=K26*(1+2%)

=L26*(1+2%)

27

Depreciation

=E26*$D$22

=F26*$D$22

=G26*$D$22

=H26*$D$22

=I26*$D$22

=J26*$D$22

=K26*$D$22

=L26*$D$22

=M26*$D$22

28

Operating Cash Flow

=E26*(1-$D$23)+E27

=F26*(1-$D$23)+F27

=G26*(1-$D$23)+G27

=H26*(1-$D$23)+H27

=I26*(1-$D$23)+I27

=J26*(1-$D$23)+J27

=K26*(1-$D$23)+K27

=L26*(1-$D$23)+L27

=M26*(1-$D$23)+M27

29

Capital Spending

=E26*$D$21

=F26*$D$21

=G26*$D$21

=H26*$D$21

=I26*$D$21

=J26*$D$21

=K26*$D$21

=L26*$D$21

=M26*$D$21

30

Net Working Capital

=E26*$D$20

=F26*$D$20

=G26*$D$20

=H26*$D$20

=I26*$D$20

=J26*$D$20

=K26*$D$20

=L26*$D$20

=M26*$D$20

31

Free cash flow

=E28-E29-E30

=F28-F29-F30

=G28-G29-G30

=H28-H29-H30

=I28-I29-I30

=J28-J29-J30

=K28-K29-K30

=L28-L29-L30

=M28-M29-M30

32

Growth Rate

=F31/E31-1

=G31/F31-1

=H31/G31-1

=I31/H31-1

=J31/I31-1

=K31/J31-1

=L31/K31-1

=M31/L31-1

33

Terminal Value

=K31/(D13-K32)

34

Present Value of Cash Flows

=E31/((1+$D$13)^E25)

=F31/((1+$D$13)^F25)

=G31/((1+$D$13)^G25)

=H31/((1+$D$13)^H25)

=I31/((1+$D$13)^I25)

=(J31+J33)/((1+$D$13)^J25)

35

Value of the company

=SUM(E34:J34)

million

36

Value of debt

=D16

million

37

Value of equity

=D35-D36

million

38

Number of shares outstanding

1.9

million

39

Maximum Share Price

=D37/2

40

41

b)

42

EBIT next Year

=D17

million

43

Depreciation Next Year

=E27

million

44

EBITDA

=D42+D43

million

45

EV/EBITDA

9

46

EV

=D44*D45

million

47

Value of debt

=D16

million

48

Value of equity

=D46-D47

million

49

Number of shares outstanding

1.9

million

50

Maximum Price per share

=D48/D49

million

51