Case Study 2

The following are the instructions for Case 2: THE LEVERAGED BUYOUT OF CHEEK PRODUCTS, INC., you have to use the APV approach in determining the value of the stock.

You have to do the following four steps:

Step 1: Calculating the present value of unlevered cash flows for the first five years, use year 2022 as your first year, and you have to use the discount rate of 14%.

in calculating unlevered cashflow, you have to use the CFFA equation = OCF - NCS -CH. NWC,

of course, you have to consider the asset sales as positive cashflow.

Step 2: Calculating the present value of the unlevered cash flows beyond the first five years, the growing perpetuity starts in year 6, so your Terminal value will be in year 5, and of course you have to bring this value back to time zero. Also, in this step, you have to use the 14 % discount rate.

Step 3: Calculating the present value of interest tax shields for the first five years using the cost of debt of 12.5% as the appropriate discount rate for the interest tax shields.

Step 4: Calculating the present value of interest tax shields beyond the first five years. Here, Ill make it very simple on you, simply calculate the interest tax shield in year 5 as 25% of your final answer in step 3. Once, you get it, simply discount it back to time zero using again the cost of debt of 12.5% as the appropriate discount rate.

Finally, you have to use MM proposition that the value of the levered firm (V) = Vu + Tc*B, where Vu is the value of the unlevered firm, and Tc*B is the PV of the Interest tax shield.

Our job is to calculate V.

Vu is simply the sum of your answers in step 1 and step 2.

Tc*B is simply the sum of your answers in step 3 and step 4.

After you get V, simply divide it by the number of shares outstanding (given in the case) to get an estimate of the price per share of the company stock.

Use the following data:

\begin{tabular}{|cccccc|} \hline & 2022 & 2023 & 2024 & 2025 & 2026 \\ \hline Interest payments & $1,690 & $1,935 & $2,280 & $2,225 & $2,300 \end{tabular}