Coorate Finance Essay Example

technological advantage, Josh's research indicates that Ragan's competitors are investigating other methods to improve efficiency.

Given this, Josh believes that Ragan'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 Ragan'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's 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, Carrington 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 want 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. (CPI) 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 company'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 . 25. 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 (LBO) is the acquisition by a small group of equity investors of a public or private company.

Generally, an LBO 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 LBO within three 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 LBO to her partners, Ben Feller and Brenton Flynn. Ben and Brenton 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 percent 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 financials and various pro forma scenarios, Ben and Brenton 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 considerable amount of the purchase price. The interest payments on the debt for each of the next five years if the LBO 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 maturity will be 8 percent. CPI currently has 167 million shares of stock outstanding that sell for $53 per share. The corporate tax rate is 40 percent. If Meg, Ben, and Brenton decide

to undertake the LBO, what is the most they should offer per share?