Yeat Valves and Control Inc for Scribd

MM 5009 FINANCIAL MANAGEMENT

Yeats Valves and Controls Inc.

R45 A– Group 3

EXECUTIVE SUMMARY

Yeats Valves and Control Inc. (YVC) were principally engaged in the manufacture of specialty valves and heat exchangers. The firm had many standard items, but nearly 40% of its volume and 50% of its profit derived from special application for the defense and aerospace industries. In 1987, as soon as the product was brought to the commercial stage, the company was organized to acquire the patents and properties, both owned and leased, of the engineering corporation. The raw material used by the company was obtained in ample supply from a number of competitive suppliers. Auden Company, a large concern in a related field, was an important foreign distribution channel under a nonexclusive distributor arrangement. About 15% of YLC sales came from Auden. Foreign sales through Auden and direct sales through YLC own staff accounted for 30% of sales. Although the foreign-currency crisis in the mid 1990s had interrupted sales growth for the company, better economic condition in the markets of developed countries, together with its recent introduction of new product in aerospace and defense industries offered the company excellent prospect for improved performance. YLCs plants were organized for efficient handling of small production orders. From 1997 to 1999, net additions to property totaled $7.6 million. The success of YLC had brought numerous overtures from companies looking for diversification, plant capacity, management efficiency, financial resources, or an offset to cyclical business. YLC feared that without a well-financed partner, the company would be swamped by competition. Thus, when a merger with TSE International Corporation came along in 1999, YLC determined to make it work as best as he could. TSE International Corporation was incorporated in 1970.by 2000, the company manufactured products ranging from advanced industrial components to chain, bolts, nuts, cables, and other similar products, and they sold them, for the most part indirectly, to various industrial users. The company's raw material came from various producers. TSE plants were modern, ample, well equipped, and adequately served by railroad sidings. From the very start of the negotiation for combining the two companies, the merits of alternative methods had been considered by counsel from both parties. Whatever terms were finally worked out, the agreement would be subject to the approval of the stockholders of both companies. I.

Objective Based on both company's financial condition, it is possible to determine whether the

merger will benefit both the company and its stockholders. In determining the decision about the merger, it is wise to put company's valuation into consideration, whether the merger will bring better value to the company or it is better to wait until the company get better valuation

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based on its effort. To determine whether merger will benefit for both company or not we must do this 1.

Estimate the value of the YVC after merger with TSE International.

2.

Determine the minimum stock price to stockholders profit from merger.

3.

Give recommendation to YVC to do merger or not.

II. Analysis In this part, we will describe the calculation about the value Yeast Valves and Control Inc. and TSE International before merger, also the value for both companies after merger. We use 4 methods to calculate the value, which is DCF (Discounted Cash Flow), P/E Ratio, Book Value and Market Value. a. DCF In discounted cash flows valuation, the value of an asset is the present value of the expected cash flows on the asset, discounted back at a rate that reflects the riskiness of these cash flows. We will be show the calculation for each company before and after merger. Yeats Valves and Control, Inc. Table 1 Yeats Valves and Controls, Inc. before merger

Yeats Valve and Control, Inc. 40% Tax 1,00 Beta 0% Cost of debt 6,6% Risk Free 5,5% Risk Premium 12,10% Cost of equity 12,10% WACC 13,23% ROE 41,30% DPO 8% Growth Rate Table 2 Value Calculation before Merger

Sales Cost of goods sold Gross profit Selling, general, admin. Other income, net Depreciation Income before tax Tax Net Income

$

Actual 1999 49.364,00 37.044 12.320 2.936 228 1.508 8.104 3.242 4.862

$

2000 59.600,00 42.316 17.284 3.612 240 1.660 12.252 4.901 7.351

$

2001 66.000,00 47.850 18.150 4.024 264 1.828 12.562 5.025 7.537

Projected 2002 $ 73.200,00 52.704 20.496 4.464 288 2.012 14.308 5.723 8.585

$

2003 81.200,00 58.058 23.142 4.952 320 2.212 16.298 6.519 9.779

$

2004 90.000,00 63.900 26.100 5.492 352 2.432 18.528 7.411 11.117

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Cash Flow Net Income Depreciation Operating Cash Flow Capital Expenditure Working Capital Free Cash Flow Terminal Cash Flow Total PV of FCF PV of TCF Total Yeats Value Debt Equity Shares Value per share

$ $ $ $ $ $ $

4.862 1.508 6.370

7.351 1.660 9.011

7.537 1.828 9.365

8.585 2.012 10.597

9.779 2.212 11.991

11.117 2.432 13.549

6.370

1.826 3.492 3.693

2.011 3.867 3.487

2.213 4.289 4.095

2.433 4.757 4.801

2.675 5.273 5.601 139.187 144.788 3.163,89

6.370 6.370,40 81.790,61 103.341,40

$

3.693 3.294,56

$

3.487 2.775,02

$

4.095 2.906,80

$

4.801 3.040,12

$

100.177,51 100.177,51 1.440.000 69,5677

Table 1 is explaining any data that needed to use in calculation to get the value of the company that shown in Table 2. This calculation involve some equation that use to get the growth and the terminal value. The equation that used is shown below. g∞ = ROE x (1 – DPO) TVFirm =

(

)

TSE International Table 3 TSE International before Merger

TSE International Tax Beta Cost of debt Risk Free Risk Premium Cost of equity C/S Cost of equity P/S WACC ROE DPO Growth Rate Share 62.694.361 Share 1.389.160,00 Long term debt Equity: C/S Equity: P/S Total rd (using BAA bond rating)

40% 1,00 6% 6,6% 5,5% 12,10% 2,00% 11,24% 16,52% 56,20% 7% Price $ 16,78 Price $ 20,00 119.100 1.052.011,38 27.783 1.198.895 9,60%

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Table 4 Value Calculation before Merger

Sales Cost of goods sold Gross profit Selling, general, admin. Depreciation Income before tax Tax Net Income Cash Flow Net Income Depreciation Operating Cash Flow Capital Expenditure Working Capital Free Cash Flow Terminal Cash Flow Total PV of FCF PV of TCF Total TSE Value Debt Equity Shares Value per share

Actual 1999 $ 2.187.208,00 1.793.511 393.697 120.296 26.800 246.601 98.640 147.961

2000 $ 2.329.373,00 1.910.086 419.287 125.786 27.950 265.551 106.220 159.331

2001 $ 2.480.785,00 2.034.244 446.541 131.482 29.770 285.289 114.116 171.173

Projected 2002 $ 2.642.037,00 2.166.470 475.567 140.028 31.700 303.839 121.536 182.303

2003 $ 2.813.769,00 2.307.291 506.478 146.316 33.170 326.992 130.797 196.195

2004 $ 2.996.658,00 2.457.260 539.398 155.826 35.960 347.612 139.045 208.567

147.961 26.800 174.761

159.331 27.950 187.281

171.173 29.770 200.943

182.303 31.700 214.003

196.195 33.170 229.365

208.567 35.960 244.527

174.761

187.281

200.943

214.003

229.365

174.761 $ 174.760,60 $ 3.991.762,37 $ 4.946.160,28 $ 4.802.578,92 $ 119.100,00 $ 4.683.478,92 62.694.361 $ 74,7034

187.281 $ 168.363,12

200.943 $ 162.398,53

214.003 $ 155.483,11

229.365 $ 149.811,19

244.527 6.553.670 6.798.198 $ 143.581,36

Merger Valuation Table 5 Merger Data 1

Share 1.440.000 Share 62.694.361 Share 1.389.160,00 Long term debt Equity: C/S Equity: P/S Total rd

Yeats Price $ 28,50 TSE Price $ 16,78 Price $ 20,00 119.000 1.093.051 27.783 1.239.835 9,60%

P/S 41.040,00 P/S 1.052.011,38 P/S 27.783,20 9,60% 88,16% 2,24%

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Table 6 Merger Data 2 Merger Tax Beta Cost of debt Risk Free Risk Premium Cost of equity C/S Cost of equity P/S WACC ROE DPO Growth Rate

40% 1,00 6% 6,6% 5,5% 12,10% 2,00% 11,27% 17,06% 48,75% 9%

Table 7 Valuation after Merger

Sales Cost of goods sold Gross profit Selling, general, admin. Other income, net Depreciation Income before tax Tax Net Income

Actual 1999

2000

2001

Projected 2002

2003

2004

$ 2.236.572,00 1.830.555 406.017 123.232 228 28.308 254.705 101.882 152.823

$ 2.388.973,00 1.952.402 436.571 129.398 240 29.610 277.803 111.121 166.682

$ 2.546.785,00 2.082.094 464.691 135.506 264 31.598 297.851 119.140 178.711

$ 2.715.237,00 2.219.174 496.063 144.492 288 33.712 318.147 127.259 190.888

$ 2.894.969,00 2.365.349 529.620 151.268 320 35.382 343.290 137.316 205.974

$3.086.658,00 2.521.160 565.498 161.318 352 38.392 366.140 146.456 219.684

152.823 28.308 181.131

166.682 29.610 196.292

178.711 31.598 210.309

190.888 33.712 224.600

205.974 35.382 241.356

219.684 38.392 258.076

181.131

1.826 3.492 190.974

2.011 3.867 204.431

2.213 4.289 218.098

2.433 4.757 234.166

181.131 181.131,00 6.472.888,91 7.448.588,85 7.301.910,36 119.000,00 7.182.910,36 64.134.361 $ 111,9978

190.974 $ 171.638,46

204.431 $ 165.130,60

218.098 $ 158.334,14

234.166 $ 152.787,26

2.675 5.273 250.128 10.787.965 11.038.093 $ 146.678,49

Cash Flow Net Income Depreciation Operating Cash Flow Capital Expenditure Working Capital Free Cash Flow Terminal Cash Flow Total PV of FCF PV of TCF Total Merger Value Debt Equity Shares Value per share

$ $ $ $ $ $

From table 2, the value of YVC is $ 100,177.51. Meanwhile, from table 4, the value of TSE International is $ 4,802,578.92. And from the table 7, we can see that the value of company after merger is $ 7,301,910.36. We can see that the value of company after merger is higher than the value from each company. It means that if both companies do the merger, it will create a good synergy. Because, as stated in the Page | 5

Modern Financial Management, “synergy occurs if the value of the combined firm after the merger is greater than the sum of the value of the acquiring firm and the value of the acquired firm before the merger”. Weakness of DCF -

The DCF model is only as good as its input assumptions

-

Valuations are particularly sensitive to assumptions about perpetuity growth rates and discount rates

-

DCF focuses on long-term values

-

Overlook unusual opportunities

b. P/E Ratio The P/E ratio reflects the amount investors are willing to pay for each dollar of earnings. The average P/E ratio in a particular industry can be used a guide to a firm’s value – if it is assumed that investors value the earnings of that firm in the same way they do the “average” firm in the industry. The price/earnings multiple approach is a popular technique used to estimate the firm’s share value; it is calculated by multiplying the firm’s expected EPS by the average P/E ratio for the industry. Table 8 EPS and PER for Yeats and TSE EPS of Yeats 3.87

Average P/E Value per share for Yeats

P/E in the Industrial Machinery Sector 8.2 10.3 11 14.6 16.3 7 10.7 10.4 11.063 42.812

EPS of TSE 2.23

Average P/E Value per share for TSE

P/E in the Industrial Machinery Sector 8.2 10.3 11 14.6 16.3 7 10.7 10.4 11.063 24.669

From table above, we can see that Yeats’s PER is higher than TSE’s. c. Book Value To calculate book value per share, we used the following formula. ∑

Book Value per share = ∑

∑

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Table 9 Book Value per Share Yeats and TSE

$ $ $ $

Total Assets Total Liabilities Total Shares Outstanding Book Value per share

Yeats 42,124,000 5,360,000 1,440,000 25.53

TSE $ 1,245,825,000 $ 350,088,000 $ 62,694,361 $ 14.29

From table 9, we can see that the book value per share from the Yeats is higher than TSE’s.

d. Market Value Based on exhibit 7, market value for Yeats on May 1, 2000 is $39.75, and market value for TSE International is $21.98. It shows that market price of Yeats is higher than TSE. Which means, the demand for Yeats share are higher than the TSE.

From the explanation above, we can conclude that the merger between Yeats and TSE will be benefit for both of them. It can be seen from the value per share that was resulted after merger. The DCF calculation above shows us that the value of the merge company is bigger than the sum of value of each company before merger. It means that there will be a good synergy. So we need to calculate the minimum stock price. Table 10 Minimum Stock Price Value DCF $ 69,57 PER $ 42,81 BV $ 25,53 Market Price $ 39,75 Minimum Stock Price

Weighted 60% 20% 10% 10%

$ $ $ $ $

41,74 8,56 2,55 3,98 56,83

We also calculated the amount money that TSE has to pay to merger with Yeats. Yeats market capitalization

= Minimum stock price x Total shares outstanding = $ 56.83 x 1,440,000 = $ 81,836,725.48

III. Conclusion and Recommendation 3.1 Conclusion Based on the calculation and analysis above, we can conclude that: Page | 7

a. The value of the company of the Yeats after merger with TSE International is $ 7,301,910.36 b. Minimum stock price that Yeats should ask to ensure that its stockholders profit from that merger is $56.83.

3.2 Recommendation Our recommendations are:  Yeats should merger with TSE International.  TSE also has to consider that if they merge with Yeats they are facing another problem, which is Bill Yeats retirement. TSE has to make sure that after Bill Yeats retires, the company will run as good as now. Because until now, the decision maker of Yeats Inc. was held by Bill Yeats as CEO of Yeats Valves. The success factor from Yeats Inc. until now is Bill Yeats himself.  Facing that situation, Yeats should apply the knowledge management, which he should share his knowledge to the employee. So, the knowledge can be transferred to the new generation of Yeats Inc.  They must create a database system to improve their company performance.

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