1 Name: Duration: 60 Mins Sec: Finance II Quiz 4  Answer the questions in the answer booklet only. Marks will be awarded only for showing ALL relevant steps. Untidy work will be penalized. Rough work should be done at the end of answer booklet only. Calculators are allowed. Maximum Marks 20 Handbook Inc. is a premier firm in social networking domain. It has a subscriber base of more than 25 million users across the world. For quite some time managers at Handbook were looking for concentration in their market share by acquiring a potential target firm in downstream operations of messaging texts on mobile phones and tablets. The EBIT for current year 2013 for Handbook stands at $2650mn, depreciation expenses are estimated to be $845mn, net capital expenditure is $168mn and working capital remains at $612mn. Working capital is growing in sync with the sales. Sales are growing at 8% for quite some time now and would be growing at the same rate for next 3 years. However, sales growth would stabilize at 4% per year for future periods. Analysts believe that free cash flows will grow at the rate of sales growth in the coming future. Cost of capital for Handbook is estimated to be 11.50%. Marginal tax rate for Handbook is 35%. Total market value of debt outstanding is $2135mn while there are 1325mn shares outstanding. Handbook has identified WhyApp Inc. as a downstream player with phenomenal track record in personalized messaging services. Handbook could see WhyApp as an organic supplement to its strategy to move towards downstream market and to concentrate its market share. WhyApp has reported an EBIT of $465mn in 2013. The gross and net capital expenditure was $675mn and $128mn respectively in 2013. Working capital in 2012 was $213mn and estimated to grow with sales in future. Free cash flows will grow with sales in future, which in turn is growing at 11% now for quite some time and will continue to grow at this rate for next 3 years. Sales will ultimately stabilize at 4% after three years. Cost of capital is estimated to be 12.65% while marginal tax rate is 35%. Total market value of debt outstanding is $856mn while there are 146mn shares outstanding. Handbook believe that by changing management (not necessarily by acquisition) for WhyApp, its EBIT would have been better by 6.5% per year, working capital would have been reduced by 5% per year while growing at the same rate as before. Also, cost of capital will be reduced to 12.10%. Capital expenditure, however, would remain same. 2 In addition to this, if WhyApp could be acquired by Handbook while being optimally managed, WhyApp’s net capital expenditure can be reduced by 5% and EBIT could be improved further by 3.5% (overall 10%), owing to the synergy that will be created out of acquisition. Further, after acquisition, cost of capital for combined firm would be 11.60%. Cash flows in Handbook per se may not get affected due to this acquisition. The combined firm and its cash flows will grow at 11% for next 3 years and then stabilize at 4% per year thereafter. Marginal tax rate remains 35%. Assuming this is end 2013, you are required to: 1. Estimate per share value of Handbook. Write steps in calculations and then perform the calculation. 5 2. Estimate current value per share for WhyApp. Write steps in calculations and then perform the calculation. 3 3. Estimate value of control per share if management is changed (without changing shareholders) in WhyApp. Write steps in calculations and then perform the calculation. 3 4. Estimate the combined value of the firm without synergy and with synergy. Identify the value due to synergy. Write steps in calculations and then perform the calculation. 4 5. Assume all of the value due to synergy comes from WhyApp, estimate the maximum value per share Handbook can offer to WhyApp. 3 6. Extending 5, in case Handbook resort to stock swaps for acquisition, estimate maximum number of Handbook share which can be offered for each share of WhyApp. 2