Organ Thermal Systems Pl was founded nine years ago by brother and sister Carination and Genevieve Organ. The company manufactures and installs commercial heating, ventilation and cooling (HAVE) units. Organ has experienced rapid growth because of a proprietary technology that Increases the energy efficiency of Its systems. The company Is owned equally by Carination and Genevieve. The original agreement between the siblings gave each 50,000 shares. In the event that either wishes to sell the shares, they first have to be offered to the other at a discounted price.
Although neither sibling wants to sell any shares at present, they have decided they should value their holdings in the company for financial planning purposes. To accomplish this, they have gathered the following information about their main competitors. I Expert HAVE ply’s negative earnings per share (PEPS) were the result of an accounting write-off last year. Without the write-off, PEPS for the company would have been в?2. 34. P. 146 Last year, Organ had an PEPS of в?4. 32 and paid a dividend to Carination and Genevieve of в?54,000 each.
The company also had a return on equity of 25 per cent. The siblings believe a required return for the company of 20 per cent Is appropriate. 1 . Assuming the company continues its current growth rate, what is the share price of the company’s equity? 2. To verify their calculations, Carination and Genevieve have hired Josh Job as a consultant. Josh was previously an equity analyst, and he has covered the HAVE industry. Josh has examined the company’s financial statements as well as those of its competitors.
Although Organ currently has a technological advantage, Josh’s research indicates that Raglan’s competitors are investigating other methods to improve efficiency. Given this, Josh believes that Raglan’s technological advantage will last for only the next five years. After that period, the company’s growth is likely to slow to the Industry average. Additionally, Josh believes that the required return the company uses Is too high. He believes the Industry average required return Is more appropriate. Under Josh’s assumptions, what is the estimated share price? 3.
What is the industry average price-earnings ratio? What is Raglan’s price-earnings ratio? Comment on any differences and explain why they may exist. 4. Assume the company’s growth rate declines to the industry average after five years. What percentage of the equity value is attributable to growth opportunities? 5. Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply? 6. After discussions with Josh, Carination and Genevieve agree that they would like to try to increase the value of the company equity.
Like many small business owners, they want to retain control of the company and do not want to sell shares to outside investors. They also feel that the company’s debt Is at a manageable level and do not ant to borrow more money. What steps can they take to Increase the share price? Are there any conditions under which this strategy would not Increase the share price? Cheek Products, Inc. (ICP) was founded 53 years ago by Joe Cheek and originally sold snack foods such as potato chips and pretzels.
Through acquisitions, the company has grown into a conglomerate with major divisions in the snack food industry, home security systems, cosmetics, and plastics. Additionally, the company has several smaller divisions. In recent years, the company has been underperforming, but the Meany’s management doesn’t seem to be aggressively pursuing opportunities to improve operations (and the stock price). Meg Whalen is a financial analyst specializing in identifying potential buyout targets. She believes that two major changes are needed at Cheek.
First, she thinks that the company would be better off if it sold several divisions and concentrated on its core competencies in snack foods and home security systems. Second, the company is financed entirely with equity. Because the cash flows of the company are relatively steady, Meg thinks the company’s debt-equity ratio should be at least . 5. She believes these changes would significantly enhance shareholder wealth, but she also believes that the existing board and company management are unlikely to take the necessary actions.
As a result, Meg thinks the company is a good candidate for a leveraged buyout. A leveraged buyout (LOBO) is the acquisition by a small group of equity investors of a public or private company. Generally, an LOBO is financed primarily with debt. The new shareholders service the heavy interest and principal payments with cash from operations and/or asset sales. Shareholders generally hope to reverse the LOBO within here to seven years by way of a public offering or sale of the company to another firm.
A buyout is therefore likely to be successful only if the firm generates enough cash to serve the debt in the early years and if the company is attractive to other buyers a few years down the road. Meg has suggested the potential LOBO to her partners, Ben Feller and Breton Flynn. Ben and Breton have asked Meg to provide projections of the cash flows for the company. Meg has provided the following estimates (in millions): At the end of five years, Meg estimates that the growth rate in cash flows will be 3. 5 recent per year. The capital expenditures are for new projects and the replacement of equipment that wears out.
Additionally, the company would realize cash flow from the sale of several divisions. Even though the company will sell these divisions, overall sales should increase because of a more concentrated effort on the remaining divisions. P. 574 After plowing through the company’s financial and various pro formal scenarios, Ben and Breton feel that in five years they will be able to sell the company to another party or take it public again. They are also aware that they will have to borrow a inconsiderable amount of the purchase price.
The interest payments on the debt for each of the next five years if the LOBO is undertaken will be these (in millions): The company currently has a required return on assets of 14 percent. Because of the high debt level, the debt will carry a yield to maturity of 12. 5 percent for the next five years. When the debt is refinanced in five years, they believe the new yield to that sell for $53 per share. The corporate tax rate is 40 percent. If Meg, Ben, and Breton decide to undertake the LOBO, what is the most they should offer per share?
