Charger Incorporated and Sparks Electrical Company are competitors in the business of electrical components distribution. Sparks is the smaller firm and has garnered the attention of the management of Charger, as Sparks has taken away market share from the larger firm by increasing its sales force over the past few years. Charger is considering a takeover offer for Sparks and has asked you to serve on the acquisition valuation team that will turn into the due diligence team if an offer is made and accepted. Given the following information and assumptions:

a. Make your recommendation about whether or not the acquisition should be pursued.
b. Assume Sparks has accepted the takeover offer from Charger, and now the new subsidiary must be consolidated within Charger’s financial statements. Taking Sparks’s most recent balance sheet and a restated market value of assets of $295.6 million, calculate the goodwill that must be booked for this transaction.
Assumptions:
• Sparks would become a wholly owned subsidiary of Charger.
• Revenues will continue to grow at 4.3% for the next five years and will level off at 4% thereafter.
• Cost of goods sold will represent 95% of revenue going forward.
• Sales force layoffs will reduce SG&A expenses to $22 million next year with a 2% growth rate going forward.
• These layoffs and other restructuring charges are expected to result in expensed restructuring charges of $30 million, $15 million, and $5 million, respectively, over the next three years.
• Noncash expenses are expected to remain around $7 million going forward.
• Interest expenses are expected to remain around $11.5 million going forward.
• A tax rate of 31% is assumed going forward.
• Charger’s cost of equity is 12%.
• Sparks’s current market capitalization is $315.7 million.
• Charger will offer Sparks a takeover premium of 20% over current market capitalization.

Transcribed Image Text:

Condensed Balance Sheet Previous Year (2011) (S in millions) S12.2 442.5 $454.7 Current assets Fixed assets Total assets Current liabilities Long-term debt Total liabilities Shareholders equity Total liabilities and equity S10.1 150.0 S160.1 294.6 $4571 Sparks Electrical Company Condensed Income Statement Previous Five Years (S in millions) 2007 S1,626.5 S1,614.1 S1,485.2 S1,380.5 S1,373.4 1488.1 14909 13595 12714 1268.0 138.4 S 23.2 125.7 1091 S 105.4 2011 2010 2009 2008 Revenues Less: Cost of goods sold Gross profit Selling, general & adminis trative expenses (SG&A) Noncash expense (depre- ciation & amortization) Less: Operating expense Operating profit (EBIT) Less: Interest expense Eamings before taxes (EBT) Less: Taxes paid Net income S 41.1 S36.8 S41.2 S 35 S 36.1 6.4 S 48.4 S43.5 S 48.3 416 42.5 S 62.9 12.0 50.9 15.3 S 542S 469 45.5 38.7 35.6 7.3 6.7 7.1 6.6 S 90.0 79.7 11.5 12.0 S 78.5 S 67.7 20.8 S 77.4 S675 12.0 S 65.4 55.5 16.8 12.0 24.3 19.9