1) A benefit to Knoll’s management and employees of going public is that after the lock up period, a

successful IPO would be lucrative for the top officials at Knoll. These officials were incentivized with
stock in the company and should Knoll remain a private company these hold little value. However, if
Knoll was to become publicly listed then this would constitute a large payoff for the management
team of Knoll.

Additionally, a benefit of the IPO is the increased visibility, recognition and prestige that comes with
been a public company. IPOs are usually gain a lot of attraction and interest especially from the media
with public companies mostly at the center of attention. Of course, we are told that Knoll does not
necessarily need increased brand awareness as it is already an established player in the industry.
However, this does not mean that the benefits do not accrue.

Lastly, we believe there will be a reduced cost of capital for Knoll as a public company. This is due to the
stricter regulations on public companies by law leading to a higher level of transparency. Quarterly
reporting and detailed company reports will all contribute to investors requiring a lower rate of return
to lend money to a public firm as opposed to a private one.

These benefits are quite small because as alluded to earlier Knoll is already an established firm with a
rich history founded in 1938. It is also been recently successful with Lynch starting to turn the company
around after a few years of declining.

2) In most situations, the main reasons of listing as a public company is to raise capital via equity
markets and to improve the company’s image and visibility. However, neither of these are applicable
to Knoll. Knoll is performing well with rapid growth after the turnaround job by Lynch and his team
and is already an established brand in the furniture industry.

A major reason of an IPO is to raise capital through the equity markets. However, we are explicitly told
that Knoll has no need for capital. Essentially, the proceeds of the IPO are not necessary for the
company. The pitfalls of holding excess cash on the balance sheet are well documented in academia.

A public offering can also be costly due to the fees paid to investment banks between 7.5-10%, lawyers
as well as sales and marketing costs which alone could cost up to $300,000. Public companies also need
to employ an investors relations team and in some cases an investment bank to be their corporate
broker. This again reflects additional costs that come from public company.

Additionally, the IPO process can also be time consuming as managers will have to spend time as part of
the IPO process in roadshows amongst other things instead of running the business as usual. Lynch
believes that the process could take up to 6 months which represents a large opportunity cost of time
since half of a year is spent away from the business. This may also be even more costly as Knoll is still
growing and as the turnaround continues. Centralisation and integration of MIS, purchasing,
manufacturing and customer service are not yet completed which requires Lynch’s attention as well as
the 20 managers reporting directly to him.

There is also a certain level of scrutiny that comes with been a public company. Every word of the
management is followed closely, and the market can react negatively should a mistake be made, or
words be misconstrued. As a public company the shareholder base can be diverse from retail investors
to activist investors each with their own ulterior motives which can make life difficult for management.
The scrutiny from shareholders and media also brings legal ramifications as there is the potential for a
shareholder class action lawsuit should the management of Knoll say something wrong.
Lastly, there a well-documented cost of becoming a public company is the likely switch of focus to
increasing short term earning rather than creating long term value. The convention for public companies
is report on earnings quarterly and these results can have a significant impact on share prices. Thus,
managers have a he incentive and are under immense pressure to perform in the short term. Markets
are notoriously impatient, irrational and short-sighted so any attempt a creating long term value at the
expense of short-term earnings which is not clearly communicated can lead to losses in market value for
the company.

Lastly, the employees of Knoll are likely to be affected due to the fact that Knoll had only started to
regain the trust of its hourly employees after the tough period it went through. The pressure and shift in
focus that comes with going public is likely to have a negative effect on this relationship.

The costs of going public to Knolls management and its employees are clearly large both in magnitude
and quantity. The costs vary from financial costs to intangible costs like a possible deterioration
between the company and its hourly employees. These costs should not be ignored at all because they
are important so should be carefully considered by Lynch as he makes the decision.

3) A large benefit to Warburg Pincus Ventures of taking Knoll public would be to write up the
investment to the value of the IPO to increase their IRR. Ultimately as investors, Warburg Pincus is
judged on its returns. Higher returns means they can collect higher fees and raise larger funds in the
future. By taking Knoll public through an IPO Warburg will get its return for buying Warburg. It is also
worth noting that proceeds from an IPO will likely be larger than selling to another private fund or a
trade sale.

Also, an IPO also allows Warburg Pincus to give its investors a large payout. It is worth noting that there
is typically lock up period in which the fund cannot sell shares for a certain period so as to prevent a
surplus of stock hitting the market all at once. An IPO allows Warburg to distribute shares to their
limited partners. These shares would now give their investors the flexibility to choose between holding
the stock or selling to realise the gains.

In terms of costs the main one would be the lock up period which would prevent Warburg from selling
their holdings immediately. This represents a certain level of risk as the company can lose value and in
an extreme case Warburg can actually make a loss on their investment once the lock up period is over.
Also, there could be a negative effect on the share price once Warburg decides to sell its shares.

Additionally, Warburg loses control of the firm by taking it public. The shareholders would become the
owners of the firm and thus gain control of the firm. This is especially relevant during the lockup period
where decisions made by shareholders can affect the value of the firm
4)
1996A 1997E 1998E 1999E 2000E 2001E
Sales 652.0 742.0 804.0 884.0 973.0 1070.0
COGS 420.0 465.0 505.0 555.0 611.0 672.0
SG&A 153.0 167.0 181.0 197.0 215.0 234.0
EBIT 79.0 110.0 118.0 132.0 147.0 164.0

EBIT 79.0 110.0 118.0 132.0 147.0 164.0

Taxes 33.2 46.2 49.6 55.4 61.7 68.9
D&A 0.0 36.0 39.0 42.0 44.0 44.0
CapEx 30.0 30.0 30.0 30.0 30.0
D(NWC) -12.0 -8.0 -10.0 -10.0 -10.0
FCF 81.8 85.4 98.6 109.3 119.1

The first step in the DCF was to get the Free Cash Flows (FCFs) of the firm. This can be easily done as the
exhibits in the case give us most of the information, we need to calculate the FCFs. Then we use the
formula: FCF=EBIT(1-t) + Depreciation – CAPEX + Change in Net Working Capital (NWC)

CoC Calculation

rf 5.10% Equity (MV) Debt D/(E+D) Beta(E) Beta(D) Beta(A)

MRP 5.00% Mity 45.80 0.00 0.00 0.78 0.00 0.78
Beta(A) 0.61 Hon 980.50 99.70 0.09 0.67 0.00 0.61
CoC 8.13% Kimball 574.90 5.80 0.01 0.61 0.00 0.60
Miller 1645.60 153.10 0.09 0.49 0.00 0.45
Steelcase NA 0.00 0.00 0.65 0.00 0.65
Tab 46.56 14.14 0.23 0.39 0.00 0.30
Median 574.90 9.97 0.05 0.63 0.00 0.61
Mean 658.67 45.46 0.07 0.60 0.00 0.56

The next step is calculating the Cost of Capital at which we can use to discount these cash flows. This is
done using the comparable companies we are given in the case. We assume a debt beta of 0 as is often
done by practitioners this is also easy here with a few of the comparable companies not having any
debt. The asset beta is then easily calculated by multiplying the equity beta by the by the equity
proportion to debt (1 – D/(E+D)). WE then use the median asset beta in the CAPM equation to get a Cost
of Capital for Knoll.

1996A 1997E 1998E 1999E 2000E 2001E

PV(FCF) 75.6 73.1 78.0 79.9 80.6
We can the easily discount the FCFs using the cost of capital.

TV Calculation
g 2.5%
TV 2168.6
PV(TV) 1467.1

Next we calculate the terminal value using the Gordon growth formula which we then discount to get
the PV again using the cost of capital of 8.13%.
 1996A 1997E 1998E 1999E 2000E 2001E
Interest Exp. 25.0 21.0 18.0 16.0 15.0
TS 10.5 8.82 7.56 6.72 6.3
PV(TS) 9.7 7.6 6.0 4.9 4.3

Since the leverage ratio of the company changes over time we use the APV method so we account for
leverage separately by calculating the tax shields. This is done by multiply the forecasted interest
expense by the tax rate of 42% and then discounting it using the cost of capital.

TV(TS) Calculation
g 0.0%
TV(TS) 79.1
PV(TV(TS)) 54.0

For the terminal value tax shield, we assume growth rate of 0 because we are told that debt level will
remain constant after 2001 thus it makes no sense to grow the tax shield due to debt. We also discount
the terminal value tax shield by rD, the cost of debt since the level of debt again remains constant past
2001. We use the discount rate of 7.96% as it is the Q1 1997 corporate yield on a A rated bond.

EV Calculation
PV(FCF) 387.2
PV(TV) 1467.1
PV(TS) 32.5
PV(TV(TS)) 54.0
EV 1940.8

We can then easily get the EV of the firm by adding the all the present values according to the APV
formula.

SP Calculation (with IPO)

EV 1940.8
IPO Proceeds 150.0
IPO Costs 165.0
Net D 243.8
Equity Value 1682.0
FDSO 46.8
SP 36.0

To account for the IPO we need to add the proceeds raised from equity markets through the IPO an
then subtract the costs of the IPO. The main costs we used was an assumption that the investment bank
collects a fee of 8.5% of the EV for all their services. We can then subtract from the net IPO proceeds
and net debt to get the Equity Value. Lastly, we divide by the number of shares outstanding to get the
share price which we estimate to be £36.

5)

Comps Equity (MV) Debt EV Sales EBITDA EV/Sales EV/EBITDA

Mity 45.80 0.00 45.80 18.7 3.9 2.4 11.7
Hon 980.50 99.70 1080.20 998.1 128.2 1.1 8.4
Kimball 574.90 5.80 580.70 923.6 96.7 0.6 6.0
Miller 1645.60 153.10 1798.70 1495.9 193.2 1.2 9.3
Steelcase NA 0.00 NA
Tab 46.56 14.14 60.70 154.45 11.632 0.4 5.2
Median 574.90 9.97 580.70 923.60 96.70 1.08 8.43
Mean 658.67 45.46 713.22 718.15 86.73 1.15 8.14
To value Knolls using comparable companies we calculated the EV/Sales and EV/EBITDA multiples for
the companies we were given. We then calculated the median multiple which we feel is more
appropriate in this case than the average.

CCA - Valuation (Sales) CCA - Valuation (EBITDA)

Sales 742.0 EBITDA 145.0

Implied EV 803.0 Implied EV 1221.8

IPO IPO
Proceeds 150.0 Proceeds 150.0
IPO Costs 68.3 IPO Costs 103.8
Net D 243.8 Net D 243.8
Equity Value 641.0 Equity Value 1024.1
FDSO 46.8 FDSO 46.8
SP 13.7 SP 21.9

Using the median multiples, we can then calculate the implied EV by getting the product of the multiple
and the denominator (Sales and EBITDA for Knoll). With this getting the implied share price is easy as we
add gross IPO Proceeds and Subtract Net Debt to get the Equity Value. Then we divide equity value by
the number of shares outstanding to get the implied share price.

Clearly there is a large discrepancy between the results of the valuation using comparable companies
and using the DCF. We believe this is due to some questionable assumptions used in the DCF valuation.
We find it absurd that the DCF assumes that Knoll grows at 10% for 5 years then suddenly this drops to
between 2%-3% (we used 2.5%) in perpetuity. This is very unrealistic as the decline in growth would
happen over time not suddenly. The sales growth over the forecasted period is most likely too high.
Also the Depreciation is consistently higher than CAPEX over this period which isn’t consistent with a
firm that grows 10% annually.

We could also argue that the discrepancy between the valuation by comparables and the DCF could be
due to the fact that the companies chosen are not good comparisons for Knoll. This will have a potential
effect on the asset beta and thus the cost of capital used in the DCF. There is clearly a lack of
homogeneity in the peer group used as the EV of Hon Industries is over 20 times larger than that of
Mity.

6) Lynch should not take Knoll public. All things considered we believe the costs outweigh the benefits.
As discussed earlier in detail, there are substantial costs to Knoll of going public and there seems to be
very little to be gained in terms of benefits of going Public.