BA540 Winter 2022 Final Group Project
This case mi
ors the many aspects of business valuation discussed in Chapter 19. It also in a nutshell summarizes/connects the many knowledge and skills related to the valuation, cost of capital, and capital structure topics that we discussed and practiced throughout the term in our course assignments, quizzes, and group projects (that is intentional). You will find specific instructions regarding the assignment at the end of this case.
The goal is to present a compelling case to management based on the details below. Part of the grade is based on clear articulation of information, assumptions, thought process behind decisions, and conclusions. Please make your analyses clear and simple to follow. Remember that in the valuation process, there can be several acceptable ways to a
ive at an estimate. Therefore, it is important that you clearly articulate your reasons behind the choice made instead of just laying out a calculation.
Finally, note that many of the skills required to complete this case are presented in chapters XXXXXXXXXXI would advise you to carefully read those chapters before beginning the analysis.
MOVEFREE, INC.: Acquisition of Ortholuv.com
MoveFree, Inc., a publicly traded firm specialize in trendy and comfortable apparel has experienced a slow growth in sales and profitability in recent years due to increased competition and market saturation. In a board meeting discussing the next strategic move, MoveFree’s CEO, Rylee Farah, proposed that the firm should consider acquisition of new business and identified Ortholuv.com as a desirable target to consider. She described the motivation for the acquisition as follows: “We are running out of profitable investment opportunities in our core apparel business, and our shareholders expect us to continue to grow. Therefore, we must look to acquisitions to expand into growing niche markets.” Ortholuv.com is a private company that specializes in providing customized orthopedic shoes and related products for people who have specific orthopedic needs and these who seek extra comfortableness and performance via customized ortho-design. While the market for providing customized orthopedic shoes for ortho-patients has remained stable, Rylee and her team see a high growth potential in the market for customized ortho-shoes in pursuit of greater comfortableness and higher performance.
MoveFree, Inc.’s common stock is cu
ently trading at $50 per share, and the firm has 100,000 shares outstanding. The book value of the common stock is $20 per share. However, as mentioned by Ms. Farah, sales had been slowing recently and the board was concerned that soon the share price would also begin to flag as investors figured out that the firm was running out of positive NPV investments. The firm has $2,000,000 market value of bonds which was issued a year ago at a coupon rate of 6.5% and cu
ently trading at a yield to maturity of 6.2%.
Your team have been hired as a consultant to MoveFree to evaluate the proposed acquisition of Ortholuv.com. There is considerable dissension among senior management and the board about whether the acquisition should be undertaken. Your job is to perform a thorough analysis of the merits of the proposed acquisition and make a recommendation to senior management.
After several meetings with MoveFree management and a review of Ortholuv’s financial performance and industry structure, you gathered the data shown in Table 1 below. The Sales Revenue forecast is based on considerations of Ortholuv’s historical performance, industry forecast, and potential enhanced growth via cross-selling to MoveFree’s customer base. The forecast data in Table 1 does not include increased sales of MoveFree’s apparel via cross-selling to Ortholuv’s customer base and administrative cost savings due to economic of scope as a result of the acquisition. The management team estimates that the combined effect of increased sales and cost savings to MoveFree’s cu
ent operation has a present value of 1.2 million.
Table 1: Forecast Data for Ortholuv.com (in $’000) (Fiscal year end is March 31)
2023
2024
2025
2026
2027
Sales Revenue
1,000.0
1,250.0
1,875.0
2,100.0
3,750.0
Investment in CapEx and NWC
25.0
55.0
170.0
80.0
80.0
Depreciation
15.0
30.0
50.0
72.0
80.0
Interest payments
94.4
101.4
108.6
115.9
122.4
Ortholuv.com cu
ently has $1,475,000 (market value) in long-term debt, with a coupon rate of 7%. Its cost of goods sold (COGS) is expected to be 42% of sales revenues, and selling, general and administrative (SG&A) expenses are expected to be 15 percent of revenues. The depreciation numbers listed above are already included in COGS percentage estimates. The firm’s corporate tax rate is 40% and its cu
ent cost of bo
owing is 6.2%.
Your research indicates that Ortholuv has a target debt to value ratio of 15%, based on its assessment of the probability and costs of financial distress. You note that this is different from the capital structure of MoveFree and wonder how this would factor into your analysis.
Although Ortholuv.com is a rapidly growing company, your analysis of industry structure suggests that competition in the customized ortho-shoes market is likely to increase in the next few years and the boost in sales growth from cross-selling to MoveFree’s customer base will also start to stabilize. Thus, you forecast that the perpetual growth rate for free cash flows beyond 2027 will be a more modest 2.0% per year.
Your analysis of market data yielded the information in Table 2 below.
Table 2: Market Data
Cu
ent yield to maturity on 30 year treasury bonds
2.50%
Cu
ent yield to maturity on 3 month treasury bills
2.0%
Most recent 1-year return on the S&P 500
5.3%
Estimate of expected average return on the S&P 500 over the next 30 years
8.0%
Your analysis of Ortholuv.com’s industry reveals that most of the firms in the industry, like Ortholuv, are private firms. However, you find a close competitor, OrthoCare.com, that is in the same line of business and is publicly traded. OrthoCare has a long-term target debt to equity ratio of 0.75, and has been historically quite close to that target. Your analysis of OrthoCare’s historical returns against the market returns yields an equity beta of 1.5. OrthoCare cu
ently has 50,000 common shares outstanding trading at $12 per share. OrthoCare had enjoyed a faster growth in the recent past since its IPO six years ago and it’s growth recently has been stabilized at a very modest rate around 2%. OrthoCare’s cu
ent company value to sales multiple is 4.5x, and company value to EBITA multiple is 10x.
ADDITIONAL GUIDELINES FOR CASE ANALYSIS
The case is due on Tuesday of the final week. Late submissions may be penalized and potentially lead to an incomplete grade for the course.
The case report (submitted in Word document or PDF file format) should be written according to the following format:
1. Introduction
2. Analysis
3. Conclusion
The introduction sets the stage for the work to follow and should consist of a short paragraph of the key problem(s) or issue(s) that your analysis addresses. The analysis will constitute the bulk of the written presentation and will be a direct response to the questions below. Use clear, concise, and complete sentences. Do not use bullet points or numbered paragraphs. The conclusion should be a short paragraph that summarizes the key points of the analysis.
Your report should be of reasonable length to address the issues/questions below. Your report should also be accompanied with one Excel file that contains all your exhibits, clearly labeled, and appropriately referenced in the text of your report.
Your analysis of “MoveFree, Inc.” should include answers to the questions below. Do not write the questions ve
atim in your report. Instead, write a
ief introductory statement that summarizes the question before you proceed with your analysis.
1) What discount rate is appropriate for finding the value of Ortholuv.com?
Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show detailed computations in your Excel spreadsheet labeled Exhibit 1.
2) What are the relevant cash flows for valuing Ortholuv.com? Assume that your valuation is performed at the end of 2020, and that the values shown in Table 1 are end-of-year forecasts.
Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show detailed computations in your Excel spreadsheet labeled Exhibit 2.
3) Based on your answers to questions (1) and (2) above, what is the maximum price that MoveFree should pay to equity shareholders for Ortholuv.com?
Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show detailed computations in your Excel spreadsheet labeled Exhibit 3.
4) Under what conditions might you consider recommending that management make a higher offer than your recommended price in (3) above?
No computations are necessary, just a short discussion.
Your report is intended for the senior management of MoveFree, Inc., so be sure that you write in a professional style that is easy to follow.