Question

January 1^st 2034, you have chosen to step down from day to day operations and have hired a former Vice President of Starbucks, George, to run Cool Beans now that the number of locations has expanded dramatically.  There are currently 72 locations that span from Miami, FL to Charleston, SC, and your coffee beans are on store shelves of Publix, Winn Dixie, and Piggly Wiggly.  You have identified an acquisition target, Crazy Mocha of Pittsburgh.  The owner is willing to sell the chain of 26 locations to Cool Beans for $52,000,000.  JP Morgan is willing to underwrite a 30 year bond with a 6% coupon to finance the purchase.   Cool Beans currently has a Beta of 1.79, the S&P 500 has been averaging 9.5% and long term treasuries are averaging 2.3%.  EBIT is up to $115,000 annually per location and $3,750,000 from bagged coffee sales.

1. What is a fair value of Crazy Mocha if their 26 locations average EBIT $115,000 with an expected growth rate of 5%, corporate tax is 21%, and their cost of capital is 10%? (3pts)

2. Do you believe the purchase price of $52,000,000 is justified? Defend your answer. (2pts)

3. What is the equity cost of capital for Cool Beans based on the Beta?  (2pts)

4.   If analysts project a 5% growth rate, what would Cool Beans’ share price be based on a Free Cash Flow valuation using the equity cost of capital before the acquisition? (5pts)

5.   If Cool Beans acquires Crazy Mocha using the 6% coupon 30 year bond, what will the new WACC be after the acquisition taking the 21% corporate tax rate into account? (8pts)  
6.   How much is the annual coupon payment on the bond?  (1pt)

7. How much will Cool Beans lower their tax expense by taking out the bond? (2pts)

8. If the 26 Crazy Mocha locations acquired also contribute $115,000 each to annual EBIT, what will the new Free Cash Flow be taking taxes and interest payments into account? (4pts)

9. What will the Enterprise Value be of the combined corporation based on the new Free Cash Flow, a 5% growth rate and the new WACC? (2pts)

10.   Subtracting the debt to get the Market Capitalization, what would the share price be after the acquisition? (2pts)

11.   After the acquisition, what is your current net worth in cash and stock?  (2pts)

Answer 1

Q1) Fair value of Crazy Mocha

The fair value of Crazy Mocha is $49,604,100

Q2) The asked is about $2.4 million more than the fair value of Crazy Mocha. In that sense the asked price of $52 million is not justified. But the acquisition can possibly lead to synergies which will make the acquisition worthwhile.

Q3) Cost of Equity of Cool Beans before Acquisition

The equity cost of capital of Cool Beans before acquisition is 15.19%

Q4) Share price of Cool Beans

The value of Cool Beans before acquisition is $97,947,438.