Valuing the Target Company of a Corporate Takeover - Essay Example

Finance and Accounting December 01, Valuing the Target Company of a Corporate Takeover Executive Summary: This paper justifies and financially analyses the target company which can be considered suitable for takeover among the 12 companies. Three companies have been chosen among these on the basis of their assets, sales and market values. The acquiring company has assets worth $ 63,078 million, while the sales are $ 42,201 million and the market value is $ 39,451 million. Since it is difficult to calculate the values of all the 12 target companies given, only 3 companies are being taken for analysis. The three companies that have been chosen are: COMPANY TICKER Assets ($ millions) Sales ($ millions) Market value ($ millions) HERSHEY CO HSY 3635 5133 7887 TATE & LYLE PLC TATYY 5719 4686 1713 WRIGLEY (WM) JR CO WWY 5232 5389 16123 The target company is valued at $ 100 million + /- $ 10000 million The independent value is $ 2500 million. Confidence interval = $100 million - $ 2500 million + 2 * $ 10000 million = $ 18500 million, which has been arrived at after calculating the WACC and the Unlevered cash flow. Assets sales market value ($millions) ($millions) ($millions) HERSHEY CO HSY 3,635 5, 133 7, 887 TATE & LYLE PLC TATYY 5,719 4, 686 1, 713 WRIGLEY (WM) JR CO WWY 5,232 5, 389 16, 123 Cost of Equity: “Kc = Rf + beta x (Km - Rf) Where, Kc is the risk-adjusted discount rate that is also known as cost of capital. Rf is the rate of a "risk-free" investment, i.e. cash. Km is the return rate of a market benchmark, like the S&P 500” (CAPM Calculator). HERSHEY CO = 0.1715 + 1.5 [1.1652 - 0.1715] = 1.6715 * 1.5 = 2.50725. TATE & LYLE PLC = 0.1493 + 1.8 [1.4563 - 0.1493] = 1.9493 *1.307 =2.5477. WRIGLEY (WM) JR CO = 0.1715 + 2.1 [1.875 - 0.1715] =2.2715 * 1.7035 = 3.8695. Cost of Debt: “Cost of debt is the main method under cost of capital in finance and financial management. It is calculated on the debt, bonds, loan or debentures by multiplying interest rate with given amount of debt. If rate is not given, then the debt rate can be calculated. This rate is called Kd. Cost of Debt = Amount of Interest (1 – Tax Rate) / Amount of Loan X 100” (Cost of Debt para. 1). HERSHEY CO Amount of Interest - 70.516 1 – Tax Rate – 1 - 244.765 = -243.765. Amount of Loan X 100 = 690.602 * 100 = 69060.2 70.516 (-243.765)/ 69060.2 = -0.00250. TATE & LYLE PLC Amount of Interest - 507.74 1 – Tax Rate – 1- 362.124 = -35.124 Amount of Loan X 100 = 6870.776 * 100 = 687077.6 507.74 (-35.124)/ 687077.6 = 17833.86/687077.6 =0.0259. WRIGLEY (WM) JR CO Amount of Interest - 3.879 1 – Tax Rate – 1 - 227.542 Amount of Loan X 100 – 0* 100 = 0 3.879(1 - 227.542) = 3.879 * -226.542 = -878.76 Weighted Average Cost of Capital: In this, the firms cost of capital is proportionally weighted. It includes all capital sources like common stock, bonds, other long-term debts, preferred stock and so on. Other things remaining same, the WACC of an industry increases as the beta and rate of return on equity raises, as a boost in WACC notes reduce in a higher risk and valuation. Following is the equation: WACC = E/V* Re + D/V * Rd * (1-Tc) Where: E = market value of the industries equity V = E + D Re = cost of equity D = market value of the industries debt Rd = cost of debt D/V = % of financing i.e. debt E/V = % of financing i.e. equity Tc = corporate tax rate E V Re D Rd D/V E/V Tc HERSHEY CO 1089.302 1779.904 2.50725 690.602 -0.00250 0.387 0.6120 244.765 TATE & LYLE PLC 1919.02 1932.18 2.5477 13.159 0.0259 0.0068 0.9931 100.107 WRIGLEY (WM) JR CO 2178.684 2178.684 3.8695 - -878.76 0 1 227.542 Following are the calculations of WACC: HERSHEY CO = 0.6120*2.50725+0.387*-0.00250(1-244.765) = 1.534437 + -0.00097 (-243.765) = 1.533467*-243.765 = -373. 81. TATE & LYLE PLC = 0.9931*2.5477+0.0068*0.0259(1-100.107) = 2.5301 + 0.00018 (-99.107) = 2.53028. WRIGLEY (WM) JR CO =1*3.8695 + 0*878.76*(1-227.542) =3.8695*-224.542 = -868.86. Total WACC of industries = -1240.14. Unlevered Cash Flows: Unlevered cash flows are those cash flows which take into account the cash inflows and outflows before any financial distribution or deduction is done. For instance, the income generated before paying interest, cash in the business before dstributing to shareholders in the form of dividends. Unlevered cash flow is equal to earnings before interest and tax – taxes + depreciation – capital expenditure – working capital HERSHEY CO 2008 2007 2006 2005 2004 Earnings before interest and tax 770.568 871.408 1004.201 979.907 902.177 (less) taxes 180.617 126.088 317.441 279.682 244.765 (Add) depreciation 170.683 187.058 184.438 203.132 189.665 (less) working capital 74.733 -192.196 -35.726 -109.283 -102.941 Unlevered free cash flow 685.901 1124.574 906.933 1012.64 950.018 TATE & LYLE PLC 2008 2007 2006 2005 2004 Earnings before interest and tax 5.72 57.545 47.245 -85.226 424.981 (less) taxes 27.17 150.807 206.692 120.012 100.107 (Add) depreciation 188.76 228.195 208.661 231.327 241.766 (less) working capital 729.3 974.29 1076.769 478.307 1144.613 Unlevered free cash flow -561.99 -839.357 -1027.78 -452.218 -577.973 WRIGLEY (WM) JR CO 2007 2006 2005 2004 Earnings before interest and tax 975.836 866.547 816.559 720.219 (less) taxes 300.158 239.67 237.408 227.542 (Add) depreciation 217.778 200.113 175.285 141.851 (less) working capital 448.658 454.098 325.283 787.94 Unlevered free cash flow 444.798 372.892 429.153 -153.412 The unlevered cash flow of the three companies have been calculated. WRIGLEY (WM) JR CO’S shows an increasing trend of unlevered cash flow. The cash flows of TATE & LYLE PLC show an increasing trend. The cash flows of HERSHEY CO. shows an increasing and decreasing trend. The profit margins of the companies are given below: 2008 207 2006 2005 2004 HERSHEY CO 311.405 214.154 559.061 493.244 590.879 TATE & LYLE PLC 92.95 384.954 421.259 -52.179 264.432 WRIGLEY (WM) JR CO - 632.005 529.377 517.252 492.954 The profits of the three firms show a decreasing trend. All these companies will benefit immensely from being a part of the conglomerate. The conglomerate will be able to suppress the three businesses as it is very strong and will be able to generate benefits from the takeover. An NPV of zero indicates that the discounted value of future cash flows is equal to the initial investment and that the desired returns will be achieved. “When NPV is zero it means that the discounted value of future cash flows equals your initial investment and you would be getting exactly the return you desire” (Kobzeff para. 8). The investment that makes cash flows realize a zero NPV is $ 13004 million. Share price = target company’s outstanding debt / outstanding shares = 6870.776+5268.122+3609.7+2244.243+1746.971 / 518+521+523.75+527.25+338.248 = 19906.46 / 2428.248 = 8.20 Compared to last year, the stock price has decreased. The takeover has been considered for the three companies WRIGLEY (WM) JR CO, TATE & LYLE PLC and HERSHEY CO and the acquisition value is $ 1240 million. Works Cited CAPM Calculator. Education Loan. n.d. Web. 01 December 2011. Cost of Debt. Accounting Education. 2010. Web. 01 December 2011. Kobzeff, James. Net Present Value (NPV): The Definition and Formula. 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