Harry Vincent, the Executive Vice President (EVP) of Monmouth, Inc. is considering acquiring a controlling stake (i.e., own more than 50% of shares) in Robertson Tool Company (RTC), a domestic manufacturer of hand tools.  You have been hired as a consultant by Harry Vincent to determine what price to pay shareholders of RTC.  Your analysis is being conducted as of end of 2002.

 

You have been given access to the projections of a task force (consisting of Harry Vincent and some of his staff) regarding the potential performance improvements to Robertson if Monmouth were to gain control of RTC.  See Exhibit AQ2 "Proforma for Robertson Tool".  Further assume that Net Working Capital is expected to be 25% of sales during each of the years in Exhibit AQ2. 

 

RTC has $12 million of debt outstanding, and the rest is equity.  RTC has no excess cash.  However, it does have some minority equity investments in other companies which you estimate based on a market multiple approach to be worth $5 million.  RTC has 584,000 shares outstanding, of which the Robertson family owns 20%, the Simmons Company owns 30.3%, and the rest held by retail investors.

A. Estimate the free cash flows of Robertson Tool Company in the explicit forecast period (i.e., 2003-2004) and in the stable growth period (i.e., 2005 and beyond) in millions of dollars, rounded to two-decimals.  Show your calculations.

 

B.  You meet with Harry Vincent to show him your free cash flow estimates.  He takes a quick look at your estimates and informs you that Simmons Company and the Robertson family would be happy to tender their shares if they receive $86/share.  

Assuming a weighted average cost of capital of 8.35% during the explicit forecast period (i.e., 2003-2004) and 8.00% in the stable growth period (i.e., 2005 and beyond), and a zero growth in FCFs in the stable growth period (i.e., 2005 and beyond), what price/share does your DCF analysis indicate?  Based on such an analysis, would you recommend that Monmouth offer $86/share to acquire a controlling stake in RTC?  If yes, what is your estimate of the value created by the acquisition for Monmouth's shareholders, measured in millions of dollars? If no, what is the highest price that you would recommend that Monmouth offer for each share of RTC, and why?  Show your calculations.

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Exhibit AQ2 ProForma for Robertson Tool (millions of dollars) Actual Forecasts 2002 2004 Sales Cost of Goods Gross Profit Sell & Admin Depreciation EBIT Tax @ 40% EBIAT COGS % Sales Sell & Admin % Sales Net Plant & Equip @ Beginning of Year Capital Expenditures Depreciation Expense Net Plant & Equip @ End of Year 55.30 35.95 19.36 13.83 2.10 3.43 1.37 2.06 65% 25% 2003 58.60 37.50 21.10 14.06 2.30 4.73 1.89 2.84 64% 24% 19.00 2.50 2.30 19.20 62.10 39.12 22.98 14.28 2.50 6.19 2.48 3.72 63% 23% 19.20 2.00 2.50 18.70 2005 to Infinity 62.10 38.50 23.60 12.42 2.70 8.48 3.39 5.09 62% 20% 18.70 2.70 2.70 18.70 Exhibit AQ2 ProForma for Robertson Tool (millions of dollars) Actual Forecasts 2002 2004 Sales Cost of Goods Gross Profit Sell & Admin Depreciation EBIT Tax @ 40% EBIAT COGS % Sales Sell & Admin % Sales Net Plant & Equip @ Beginning of Year Capital Expenditures Depreciation Expense Net Plant & Equip @ End of Year 55.30 35.95 19.36 13.83 2.10 3.43 1.37 2.06 65% 25% 2003 58.60 37.50 21.10 14.06 2.30 4.73 1.89 2.84 64% 24% 19.00 2.50 2.30 19.20 62.10 39.12 22.98 14.28 2.50 6.19 2.48 3.72 63% 23% 19.20 2.00 2.50 18.70 2005 to Infinity 62.10 38.50 23.60 12.42 2.70 8.48 3.39 5.09 62% 20% 18.70 2.70 2.70 18.70