MA-Application of Prospective Analysis
MA-Application of Prospective Analysis
A multinational food and beverage company International Food is considering to make a bid for
publicly traded nut grower, Earthy Nut. International Food approached the investment bank to come
up with the valuation of Earthy Nut.
Following are the estimates of the rates for the planning period of 5 years.
For considering the discount rate, the investment bankers looked for comparable companies.
In order to reduce the estimation error, they followed the approach of calculating the WACC of
comparable companies and then took an average of the WACC. This average WACC they used as
WACC for the target company Earthy Nut.
Earthy Nut was trading on the exchange at $20.2 per share with 3.5 million shares outstanding. The
book value of debt is $33 million.
International Food believes that the acquisition will create improved cost efficiency for Earthy Nut. In
particular, being part of the International Food network improves the efficiency of Earthy Nut’s
working capital management and its marketing and distribution operations.
International Food needs to account for the synergies in terms of cost efficiencies to calculate the
value with the synergy for Earthy Nut. The merger will also improve accounts receivable and inventory
management such that net working capital turnover is anticipated to increase by one unit of turnover.
All of the synergies are expected to be realized within the five year forecast period.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Revenue growth 0% 2.50% 4.50% 6.50% 5.50% 4.50%
Gross Margin 32.90% 33% 34.00% 35.00% 36.00% 36.00%
SG&A expense 25.40% 23.00% 23.00% 23.00% 22.50% 22.50%
Depreciation/Net PPE 10% 10% 10% 10% 10% 10%
NWC Turnover 4.4 6 6.2 6.5 6.8 7
Net PPE Turnover 1.75 1.8 1.9 2 2 2
Tax rate 35%
Discount rate 8%
Terminal Growth rate 4.50%
Based on the DCF analysis with synergies, the investment bank found the enterprise value of Earthy
Nut. What is the maximum amount which International Food can offer? If there is some uncertainty
in the realization of the margin gains, what is the new Enterprise value of Earthy Nut if you remove
gains due to cost efficiency?
If one eliminates working capital gains, but not the margin gains, what is the Enterprise value of
Earthy Nut?