A group of Holmes' top management is interested in acquiring Holmes in an LBO.

a. Briefly describe the factors that make Holmes an attractive and, conversely, an unattractive LBO candidate.

b. (This question requires coverage of Chapter 10.) Prepare projected financial statements for Holmes Corporation for Year 16 through Year 20 excluding all financing. That is, project the amount of operating income after taxes, assets, and cash flows from operating and investing activities. State the underlying assumptions made.

c. Ascertain the value of Holmes' common shareholders' equity using the present value of its future cash flows valuation approach. Assume a risk-free interest rate of 4.2% and a market premium of 5.0%. Note that information in Requirement e may be helpful in this valuation. Assume the following financing structure for the LBO:

aHolmes must repay principal and interest in equal annual payments.
d. (This question requires coverage of Chapter 13.) Ascertain the value of Holmes' common shareholders' equity using the residual income approach.
e. (This question requires coverage of Chapter 14.) Ascertain the value of Holmes' common shareholders' equity using the residual ROCE model and the price-to-earnings ratio and the market value to book value of comparable companies' approaches. Selected data for similar companies for Year 15 appear in the following table (amounts in millions):

f. Would you attempt to acquire Holmes Corporation after completing the analyses in Requirements a-e? If not, how would you change the analyses to make this an attractive LBO?
Holmes Corporation is a leading designer and manufacturer of material handling and process equipment for heavy industry in the United States and abroad. Its sales have more than doubled, and its earnings have increased more than sixfold in the past five years. In material handling, Holmes is a major producer of electric overhead and gantry cranes, ranging from 5 tons in capacity to 600-ton giants, the latter used primarily in nuclear and conventional power-generating plants. It also builds underhung cranes and monorail systems for general industrial use carrying loads up to 40 tons, railcar movers, railroad and mass transit shop maintenance equipment, and a broad line of advanced package conveyors. Holmes is a world leader in evaporation and crystallization systems and furnishes dryers, heat exchangers, and filters to complete its line of chemical processing equipment sold internationally to the chemical, fertilizer, food, drug, and paper industries. For the metallurgical industry, it designs and manufactures electric arc and induction furnaces, cupolas, ladles, and hot metal distribution equipment.
The information below and on the following pages appears in the Year 15 annual report of Holmes Corporation.

*All per-share amounts throughout the case have already been adjusted for June, Year 15, and June, Year 14, 5-for-4 stock distributions.

Year 15 was a pleasant surprise for all of us at Holmes Corporation. When the year started, it looked as though Year 15 would be a good year but not up to the record performance of Year 14. However, due to the excellent performance of our employees and the benefit of a favorable acquisition, Year 15 produced both record earnings and the largest cash dividend outlay in the company's 93-year history.
There is no doubt that some of the attractive orders received in late Year 12 and early Year 13 contributed to Year 15 profit. But of major significance was our organization's favorable response to several new management policies instituted to emphasize higher corporate profitability.
Year 15 showed a net profit on net sales of 6.4%, which not only exceeded the 6.0% of last year but represents the highest net margin in several decades.
Net sales for the year were $102,698,836, down 6% from the $109,372,718 of a year ago but still the second largest volume in our history. Net earnings, however, set a new record at $6,601,908, or $3.62 per common share, which slightly exceeded the $6,583,360, or $3.61 per common share earned last year.
Cash dividends of $2,241,892 paid in Year 15 were 57% above the $1,426,502 paid a year ago. The record total resulted from your Board's approval of two increases during the year.
When we implemented the 5-for-4 stock distribution in June, Year 15, we maintained the quarterly dividend rate of $0.325 on the increased number of shares for the January payment. Then, in December, Year 15, we increased the quarterly rate to $0.375 per share.
Year 15 certainly was not the most exuberant year in the capital equipment markets. Fortunately, our heavy involvement in ecology improvement, power generation, and international markets continued to serve us well, with the result that new orders of $95,436,103 were 18% over the $80,707,576 of Year 14.
Economists have predicted a substantial capital spending upturn for well over a year, but, so far, our customers have displayed stubborn reluctance to place new orders amid the uncertainty concerning the economy. Confidence is the answer. As soon as potential buyers can see clearly the future direction of the economy, we expect the unleashing of a large latent demand for capital goods, producing a much-expanded market for Holmes' products. Fortunately, the accelerating pace of international markets continues to yield new business.
Year 15 was an excellent year on the international front as our foreign customers continue to recognize our technological leadership in several product lines. Net sales of Holmes products

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Type Term debt Subordinated debt Shareholders' equity Proportion 50% 25 25 Interest Rate 8% 12% Term 7-year amortizationa 10-year amortization GI Handling Systems Conveyor Systems $28,998 $2,020 15,197 5,098 7,473 $20,000 Gelas Corp Industrial Furnaces LUG Industries ее Robotics Conveyor Systems $4,214 309 $2,634 736 $1,551 $6,915 Industry Cranes Sales Net income Assets Long-term debt Common shareholders' equity Market value of common equity Market beta $123,034 $ 9,872 72,518 $23,745 38,939 $102,667 099 $75,830 5,117 $41,665 8,869 $26,884 $41,962 1.12 0.88 0.93 Year 15 Year 14 Net sales Net earnings Net earnings per share Cash dividends paid Cash dividends per share Shareholders' equity Shareholders' equity per share Working capital Orders received Unfilled orders at end of period Average number of common shares $102,698,836 6,601,908 3.62 2,241,892 1.22 29,333,803 16.07* 23,100,863 95,436,103 77,455,900 $109,372,718 6,583,360 3.61 1,426,502 0.78* 24,659,214 1351 19,029,626 80,707 5% 84,718,633 outstanding during period 1,824,853* 1,824,754 Year 15 Year 14 Net Sales Net Earnings $1,602,837 1,727,112 1,505,118 1,766,841 $6,601,908 Per Share Net Sales First quarter Second quarter Third quarter Fourth quarter $ 25,931,457 24,390,079 25327,226 27050,074 102,698,836 $0.88 0.95 0.82 0.97 $3.62 21,768,077 28,514,298 28,798,564 30,291,779 $109,372,718 Net Earnings $1,126,470 1,716,910 1,510,958 2,229,022 $6,583,360 Per Share $0.62 0.94 0.82 1.23 $3.61