This problem set is designed to help you understand the way buyout deals are valued, as well as giving you practice in applying the APV method of valuing companies and using the Growth-In-Perpetuity Model to calculate terminal values. The problem is based on the case ‘Berkshire Partners: Bidding for Carter’s’, it provides exposure to the issues that arise when making a competitive bid.
In addition to the class presentation slides, you will find the notes,The Adjusted Present Value Method for Capital Assets,helpful in completing the problem set.
To answer the questions below you will first need to construct an Excel spreadsheet summarising the key projected financial parameters of the William Carter Company, using the information provided in the case and additional information provided below. Once you have done this, you will need to add to the spreadsheet the projections necessary for calculating APV using the approach to calculating APVs explained in class and in the note.
To assist you with this I have provided the spreadsheetLBO Problem Set Spreadsheet Template.xlsx. Once you have constructed the spreadsheet, you will be able to answer Questions (1) through (8), which are designed to lead you through the steps necessary for calculating the value of Carter’s. The answers to subsequent questions will be straightforward and take little time.
Hints For Getting Started
First, construct a spreadsheet that enables you to project Carter’s income statement, after tax cash flow, and debt balances at the beginning and end of each year for the years 2002 through 2006 usingmanagement’sprojections shown in the case. Assume net working capital required in each year is equal to 18% of net sales in that year and a tax-rate of 40%.
To simplify your task, assume use of Goldman’s staple-on finance facility for the debt but assume there is only a single tranche of senior debt with an interest rate of 9.6%, rather than the more complicated debt structure shown in Exhibit 6 of the case. Furthermore, use $317.5 million as the beginning amount of senior debt in 2002. You will see this is the same amount as the total beginning debt implied by the staple-on financing facility in Exhibit 6 (ensure you understand how this figure is arrived at).
NB:If you construct the spreadsheet properly and use correct assumptions, the debt balance at the end of 2006 should be close to $136.7 million. If not, you have made a mistake somewhere and you should not go any further until your spreadsheet projects this figure.
- What is Carter’s after tax cash flow in 2006, using the forecasts provided by Carter’s management?
- What is the Equity Discount Rate in this situation?
Hint: Information about what to assume as the risk-free-rate and the information necessary to calculate the Asset Beta can be found in the case. Assume the Equity Market Premium is 7.7%, which is the difference between US stock mark returns and the yields of intermediate–term government bonds from 1926 to 2000, as calculated by Ibbotson Associates.
- Based on management’s forecast financials, what is the NPV of Carter’s cashflows from 2002 to 2006, assuming Carter's is financed only with equity?
Hint: Add pro-forma projections of cash flows to your spreadsheet assuming Carter’s is financed only with equity.
- Based on management’s forecast financials, what is the terminal value at the end of 2006 of Carter’s cash flows using the Growth-In-Perpetuity model?
Hint: Add to your spreadsheet the calculation of the terminal value, using the Growth-in-Perpetuity model and assuming the perpetual growth rate is 4%
- What is the NPV of Carter’s terminal value?
- Based on management’s forecast financials, what is the NPV of the interest tax shields from 2002 to 2006?
Hint: Add to your spreadsheet the projections necessary to calculate interest tax shields. Ignore the value of the interest tax shields after 2006 (ie, don’t calculate a terminal value for the interest tax shields).
- What Enterprise Value for Carter’s does the APV valuation technique yield, based on management’s projections, and your answers above?
- Based on the answer to Question (7), what would be the Equity Value of Carter’s; based on management’s projections and assuming Goldman’s staple-on financing facility is used?
- What is the Enterprise Value of Carter’s, assuming historical sales growth and EBITDA margins (instead of management’s projections)?
Hint: Modify your spreadsheet so that Net Sales and EBITDA are calculated using historical sales growth and historical EBITDA margins, rather than the figures projected by management. Repeat the APV calculation using these different assumptions. Exhibit 4 provides historical financial results from 1997 to 2000 and Exhibit 7a provides estimated results for 2001. This information can be analysed to calculate the average historical growth (1997-2001) in Net Sales and the average EBITDA margin. Such an analysis shows average Net Sales growth in 1997-2001 was 11.2% and average EBITDA margin was 11.3%. Assume Depreciation and Amortisation and Capital Expenditure remain the same as assumed by management, and working capital continues to be 18% of Net Sales.
- Based on the answer to Question (9), what would be the Equity Value of Carter’s, using historical growth in Net Sales and EBITDA margin and assuming Goldman’s staple-on financing facility is used?
- Taking into account your answers to the above questions and all information in the case, would you make a bid for Carter’s – Yes or No?
Hint: You do not have to accept either management’s projections or the historical projection. You can use your model to make your own personal projections based on what you personally feel are the best assumptions to make about the rate of sales growth and the EBITDA margin percentage, taking into account all of the information in the case and your own belief as to how successful Carter’s management might be in making improvements to the business.
- If the answer to Question (11) is “Yes”, what would be the value of your Equity bid, assuming you use Goldman’s staple-on financing facility?
- With regard to your answers to Questions 11 and 12, what did you personally assume in your model to be the rate of sales growth and the EBITDA margin percentage – ie, management’s assumption, the historical assumptions, or your own assumptions? If you used your own assumptions of sales growth/EBITDA margin, indicate what assumptions you used.