print-to-fit case study of Finance Solution

MMS 173046: Rabia Mehreen
Assignment: Print –to-fit
Question No.1: How should C.J. Nickels approach the problem of valuing Print-to-Fit Inc?
How is this valuation problem similar to the way that analysts might value financial assets
such as corporate bonds and common stock?
C.J. Nickels may approach the problem of valuing Print-to-Fit Inc. through different valuation
methods like dividend discount model, Capital Assets Pricing Model, comparables approach and
cash based models. However, due to the availability of information they can used cash based
methods for valuation of Print-to-Fit Inc. There are two common cash based model of valuation
are used. First, free cash flow method (FCF) which is also known as operating free cash flow or
WACC approach and incorporates cash flows related to both debt and equity providers. Second,
residual equity cash flow (RECF) method which incorporates the cash flows associated with only
stockholders.
The main difference between operating free cash flow or WACC approach (FCF) and residual
equity cash flow (RECF) method is that either you redeem or intact the loan. The former method
assumes that loan is intact with business while the later assumes that loan is redeemed because
we subtract the loan amount in this method.
Print-to-Fit’s valuation problem is similar to the valuation of financial assets such as corporate
bonds and common stock because in case of acquisition we are required to find the intrinsic or
fair value of the firm that we are going to acquire. These valuation models compute the fair value
for the acquisition purpose to make a decision either to acquire or not to acquire the firm.
Question No.2 (a) Project the total cashflows that the acquired firm will provide to owners
of its debt and equity securities
Free Cash Flow/WAAC Approach/Operating Free Cash Flow Method
1994 1995 1996 1997
EBIT 3028.3 2480.2 2823.3 3004.6
Less: Tax (1,120.5) (917.7) (1,044.6) (1,111.7)
Add: Depreciation 85.80 132.40 178.30 245.80
Less: Capital Expenditures (1,631.1) (94.8) (8.2) 126.1
±∆Working Capital (1,122.7) (1,704.8) 230.8 (1,745.5)
FCF (760.2) (104.7) 2,179.6 519.3
b. Project the cashflows that the acquired firm will provide to holders of its equity
securities.
Residual Equity Cash Flow Method
1994 1995 1996 1997
Net Income 1400.6 1266.6 1670.2 1793.2
±∆Working Capital (1,122.7) (1,704.8) 230.8 (1,745.5)
1
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±∆Loan 432.6 1,214.8 (760.5) 644.3
RECF (834.8) 814.2 1,310.6 1,063.9
Question No.3: Why is a single estimate of future cashflows appropriate for valuing
financial assets, while business acquisitions normally require a number of different cash flow
estimates?
A single estimate is appropriate for financial assets because these are either linked with
cashflows attributable to only equity or debt providers. Whereas, in case of business acquisition
number of cashflows are normally required such as sales, production, operations of the business,
growth factors, interest rates, inflation, money supply etc. these factors are important for the
estimation of whole business cashflows as either they effect positively or adversely to the
cashflows due to increase or decrease.
Question No.4: What are Print-to-Fit’s (a) weighted average cost of capital, and (b)
required return on equity capital?
Weighted Average Cost Capital for the Year 1997
Items (W) Old (W) New K W*K (Old) W*K (New)
Equity 0.7 0.7 0.18 0.126 0.126
Long Term Debt 0.1 0.1 0.19 0.019 0.019
Current Debt Obligations (50%) 0.2 0.1 0.58 0.116 0.058
Total 0.261 0.203
Cost of Equity-1997
Net Income 1793.2
Total Equity 9967.3
Ke 0.18
Cost of Debt-1997
Current Debt Obligations (50%) 350.35
Non-Convertible Debt 1051.8
Capitalized Lease 19.8
Long Term Debt 1071.6
Interest Expense 203.6
KSD 0.58
KLD 0.19
2

Question No.5: What are the total annual net cashflows that the Print-to-Fit’s debt and
equity holders will receive from the firm over the 1994 to 1997 period?
1994 1995 1996 1997
EBIT 3028.3 2480.2 2823.3 3004.6
Less: Tax (1,120.5) (917.7) (1,044.6) (1,111.7)
±∆Working Capital (1,122.7) (1,704.8) 230.8 (1,745.5)
FCF (760.2) (104.7) 2,179.6 519.3
Question No.6: Based on the forecast book value of Print-to-Fit’s total capitalization in
1997, what is the projected terminal value of the firm in this year?
Based on the perpetual value of Print-to-Fit’s earnings stream available to the firm’s debt and
equity provider in 1997, what is the projected terminal value of the firm in that year?
1993 1994 1995 1996 1997
EBIT 3028.3 2480.2 2823.3 3004.6
Less: Tax (1,120.5) (917.7) (1,044.6) (1,111.7)
±∆Working Capital (1,122.7) (1,704.8) 230.8 (1,745.5)
FCF (760.2) (104.7) 2,179.6 519.3
PVF (WACC= 0.203) 1.000 0.831 0.691 0.574 0.477
PV (631.9) (72.3) 1,251.9 247.9
PV(1994-1997) 795.6
TerminalValue=
FCF(1+g)
WACC−g
Calculation of Growth: See Appendix B for detail
Gordon Method Simple Average Method Last Year Growth
0.27
Cash stream from FCF (0.76) (0.76)
Cash stream from RECF 0.21 (0.19)
Costs of equity and total capital: See question No. 4
WACC 0.203
Ke .18
Note: According to this table we cannot use any value of “g” for terminal value using calculated through
different ways because all these values of “g” are either negative or greater than WACC and Ke. Hence
we assumed “g” as 0.10.
3

Terminal Value Calculation
FCF 519.3
g 0.10
WACC 0.203
Terminal Value 5,545.90
Question No.7: Given in answers of questions 5 and 6, what is the total acquisition value of
Print-to-Fit?
PV-1994-1997 795.6
PV-1997 & Onward (5545.90*0.477) 2647.95
Total acquisition value 3,443.6
Question No.9: Based on (a) the total capitalization of Print-to-Fit Inc. (b) the total income
that providers of the firm’s debt and equity capital will receive over the 1994-97 period, what is
the total return on capital offered by the firm over the period of 1994-97?
Assumption for Return on Capital Employed
If we have data for long term then due to law of averages the logical is to use average of overall
time period. On the other hand, if we have short term data then it’s cogent to calculate only last
(current) year data. In case of Print-to-Fit we have data for short term, hence, it is logical to use
the only last year data for ROCE calculation.
Return On Capital Employed for the Year 1997
Item 1997
EBIT 3004.6
Total Equity 9967.3
LTD 1071.6
ROCE 0.27
Question No.10: What are the annual net cashflows that Print-to-Fit’s equity holders will
receive from the firm over the 1994 to 1997 period?
1994 1995 1996 1997
Net Income 1400.6 1266.6 1670.2 1793.2
±∆Working Capital (1,122.7) (1,704.8) 230.8 (1,745.5)
±∆Loan 432.6 1,214.8 (760.5) 644.3
RECF (834.8) 814.2 1,310.6 1,063.9
4

Question No.11: Based on the forecast book value of Print-to-Fit’s shareholders equity in
1997, what is the projected terminal value of the firm in this year?
Based on the perpetual value of Print-to-Fit’s earnings stream available to the firm’s equity
provider in 1997, what is the projected terminal value of the firm in that year?
1993 1994 1995 1996 1997
Net Income 1400.6 1266.6 1670.2 1793.2
±∆Working Capital (1,122.7) (1,704.8) 230.8 (1,745.5)
±∆Loan 432.6 1,214.8 (760.5) 644.3
RECF (834.8) 814.2 1,310.6 1,063.9
PVF (Ke= 0.18) 1.000 0.847 0.718 0.609 0.516
PV (707.5) 584.7 797.7 548.7
PV(1993-1997) 1,223.7
TerminalValue=
RECF(1+g)
Ke−g
Terminal Value Calculation
RECF 1,063.9
g 0.10
Ke 0.18
Terminal Value 14,645.41
Question No.12: Combining the cashflows developed in questions 10 and 11, what is the
total acquisition value of Print-to-Fit?
Total acquisition value
PV-1993-1997 1,223.7
PV-1997 & Onward (14,645.41*0.516) 7553.94
Total acquisition value 8,777.6
5

Question No.13: Based on the shareholder’s investment in Print-to-Fit Inc. and the annual
income that these investors will receive over the 1994-97 period, what is the return on equity
capital that the firm will provide over the 1994-97 period?
Assumption for Return on Equity Capital
If we have data for long term then due to law of averages the logical is to use average of overall
time period. On the other hand, if we have short term data then it’s cogent to calculate only last
(current) year data. In case of Print-to-Fit we have data for short term, hence, it is logical to use
the only last year data for ROE calculation.
Return On Equity Capital for the Year 1997
Item 1997
Net Income 1793.2
Total Equity 9967.3
ROE 0.18
Question No.14: What is the total value that C.J. Nickel’s plan to pay to acquire Print-to-
Fit Inc.? Given the range of corporate valuation estimates that you developed in question 4
through 13, should Nickel’s proceed with this acquisition? Why or why not?
Nickel should not go for acquisition because they want to acquire at 81.32 but according to these
cash flow methods the value of Print-to-Fit is around 35.5 and 20.88. This is because of assumed
growth rate I have used in this question. We assume “g” because through simple average method,
last year’s growth and Gordon model of growth it is either negative or higher from WACC and
Ke, see appendix B.
6

Appendix-A
Capital Expenditures
1993 1994 1995 1996 1997
PPE 1,030.6 2,661.7 2,756.5 2,764.7 2,638.6
∆ in PPE 1,631.1 94.8 8.2 (126.1)
±∆ in PPE (1,631.1) (94.8) (8.2) 126.1
Working Capital
1993 1994 1995 1996 1997
Inventories 1225.2 2409 3019.2 2769.1 3672.3
Add: Receivables 1200.7 2046.8 2762 2893.6 3912.9
Less: Payables (843.5) (1,750.7) (1,371.3) (1,483.6) (1,660.6)
NWC 1582.4 2705.1 4409.9 4179.1 5924.6
∆ NWC 1,122.7 1,704.8 (230.8) 1,745.5
±∆ NWC (1,122.7) (1,704.8) 230.8 (1,745.5)
Change in Loan
1993 1994 1995 1996 1997
Current Debt Obligations 221.3 550.2 756.1 22.5 700.7
Non-Convertible Debt 0 103.7 1112.6 1085.7 1051.8
Loan (Principal Amount) 221.3 653.9 1868.7 1108.2 1752.5
±∆Loan 432.6 1,214.8 (760.5) 644.3
Appendix-B
Gordon Model for the calculation of growth 1997
EBIT 3004.6
Equity 9967.3
LTD 1051.8
ROCE 0.273
Net Income 1793.2
No. of Shares 50,000
EPS 0.036
Retention Ratio 1
Growth or "g" 0.27
7

Simple Average Method of growth using only positive cash flow streams
1994 1995 1996 1997 Growth “g”
Cash stream from FCF (760.2) (104.7) 2,179.6 519.3
(0.76)
Cash stream from RECF (834.8) 814.2 1,310.6 1,063.9
0.6 (0.19) 0.21
Calculation of growth for only last year
1994 1995 1996 1997
Cash stream from FCF (760.2) (104.7) 2,179.6 519.3
(0.76)
Cash stream from RECF (834.8) 814.2 1,310.6 1,063.9
(0.19)
8
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