Fojtasek financing problem is very common to many other family companies. Family members are not interested in the family business, they would rather liquidate their equity and use it to do something else. Compare with traditional buy-out and leveraged recapitalization, the offer from Heritage seems the best option even though the price is undervalued. The first reason, Heritage Partners is an expert in the market segment of mature but successful family companies. They are aware of the firm’s operating activities, from manufacturing to distribution, to services with customers. Their expertise helps Fojtasek maintain a stable revenue and profit. The most significant concern is that the offer from Heritage Partners helps Fojtasek to avoid the fear of losing control to the firm and a huge interest expense payment from long term debt that is implied by traditional buy-out and leveraged recapitalizations.
Fair market value of the firm:
Rm: Prime rate = 9% rf: risk free rate = 7.2% Average Unleveraged beta bu = = .839 Assume that growth rate : g = 2%, RPm = 4% , tax rate is 35% Unlevered cost of equity rsu = rf + RPm (bu) = 7.2% + 4%(.839) = 10.56% Operating cash flow using base case projections:
19951996199719981999
Cash Flow7,7729,2339,80710,29210,513
Interest Expenses3,5873,0422,3241,507599
Interest * Tax rate1255.451064.7813.4527.45209.65
TV1999 = 10513 + (10513*1.02)/(10.56%-2% ) = $135.81 Million Vunlevered = Net present value of future operating cash flow = $ 110.9 million. The firm cost of debt: Rd = 9% + 1.5% = 10.5%
V taxshield= Net present value of interest tax savings = $3 million Fair market value of the firm = 110.9+ 3 = $113.9 M
Operating cash flow using management case projections: This case yields very high growth rate. Assume growth rate is 6%
19951996199719981999
Cash Flow7353922410,72412,30813,736
Interest Exp.3,6103,0912,3291,349226
Interest * Tax Rate1263.51081.85815.15472.1579.1
TV1999 = 13736 + (13736*1.06)/(10.56%-6% ) = 333,037
Vunlevered = Net present value of future operating cash flow = $ 232 million. V taxshield= Net present value of interest tax savings = $ 3 million Fair market value of the firm = 232 + 3 = $235M
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