The Case Charging Corporation and Sparking Electrical Company are competitors in the business of electrical components distribution.
Question:
The Case
Charging Corporation and Sparking Electrical Company are competitors in the business of electrical components distribution. Sparking is the smaller firm and has attracted the attention of the management of Charging, for Sparking has taken away market share from the larger firm by increasing its sales force over the past few years.Charging is considering a takeover offer for Sparking and asked you to serve on the acquisition valuation team that will turn into due diligence team if an offer is made and accepted. Given the financial information and proposal assumptions that follows, how would you respond to (a) and (b)?
Sparking Electrical Company
Condensed Income Statement
Previous five years (in $million)
2009
2008
2007
2006
2005
Revenues
$1,626.50
1614.10
1485.20
1380.50
1373.40
- Cost of goods sold
1.488.10
1490.90
1359.50
1271.40
1268.00
Gross profits
$138.40
123.20
125.70
109.10
105.40
SG&A expenses
41.1
36.8
41.2
35
36.1
Noncash expense (depreciation & Amortization)
7.3
6.7
7.1
6.6
6.4
Less : Operating expense
48.4
43.5
48.3
41.6
42.5
Operating income
90.00
79.70
77.40
67.50
62.90
- Interest expense
11.5
12
12
12
12
Earnings before taxed (EBT)
78.5
67.70
65.40
55.50
50.90
Less: Taxes paid (31%)
24.3
20.8
19.9
16.8
15.3
Net Income
54.2
46.90
45.50
38.70
35.60
Sparking Electrical Company Condensed
Balance Sheet Previous Year ($million)
2009
Current Asset
12.2
Fixed Asset
442.5
Total Asset
454.7
Current liabilities
10.1
Long Term debt
150
Total Liabilities
160.1
Shareholders' equity
294.6
Total Liabilities and equity
454.7
Assumptions
i.Sparking would become a wholly owned subsidiary of Charging.
ii.Revenues will continue to grow to 4.3% for the next five years and will level off at 4% thereafter.
iii.The cost of goods sold will represent 95% of revenue going forward.
iv.Sales-force layoff will reduce Sales, general and Administration expenses to $22 million next year, with a 2% growth rate going forward.
v.These layoff and other restructuring charges are expected to result in expensed restructuring charges of $30 million, $15 million, and $5 million (respectively) over the three years period.
vi.Noncash expenses are expected to remain around $7 million going forward.
vii.Interest expense are expected to remain around$11.5 million going forward
viii.A tax rate of 31% is assumed going forward.
ix.Charging's cost of equity is 12%
x.Sparking's current market capitalization is $315.7 million.
xi.Charging will offer Sparking a takeover premium of 20% over current market capitalization.
QUESTIONS
a)Make your recommendation about whether or not the acquisition should be pursued
(4 marks)
b)Assume that Sparkling has accepted the takeoffer offer from Charging, and that the new subsidiary must now be consolidated within Charging's financial statement. Taking Sparkling' 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.
(5 marks)
c)IfCharging's shares are currently trading at $62.43, then how many shares should Charging offer for every share of Sparking offer for every share of Sparking?
(1 mark)