Monmouth Inc. Case Solution
Similarly, the cost of selling can be reduced since there is an overlap of sales force between the two companies. The sales forces that have been established overtime by Monmouth for its previously acquired businesses can be used for Robertson as well. This will reduce the need of additional marginal selling activities, such as advertising and selling other selling expense. Thus, there will be a reduction of 3% in selling, general, and administrative expense.
Besides this, the acquisition target has a developed distribution system that would be a value addition to Monmouthâ€™s business. The company can sell its products to a new market segment using the distribution channels of Robertson. This will increase the sales significantly and make the companyâ€™s product prominent in these markets.
There are other synergies, such as by allowing the Robertsonâ€™s management to continue operations, Monmouth will save recruitment cost and this will help in initial successful operations since the management has a greater understanding of the business and knowledge of the underlying issues and market conditions. The duplication of resources will be eliminated such as account department and research department can be merged in order to reduce the cost.
Moreover, considering the current situation, Monmouth has gain some bargaining power and where it can make offer to Robertson instead of accepting Simmons deal. There was Â possibly another source of earnings, which is not quantified but theoretically, it is more likely to increase sales and profitability for the consolidated firm. With all these facts, being Mr. Vincent, an effort should be made to obtain the control without further delay.
Valuation
Weighted Average Cost of Capital
To estimate the value of the company based on the discounted cash flow method, the weighted average cost of capital for the company has to be calculated. The information has been provided in the case exhibits, which will be used to estimate the cost of capital for Robertson.
Equity beta has been averaged, from the quasi-comparable firmsâ€™ data. The beta is taken as 1.05, which is then levered as per the companyâ€™s capital structure. The formula used for levering the beta is as follows:
Leveredbeta = Unlevered beta (1+ (1-t) (Debt/Equity))
The debt to equity ratio for Robertson is calculated using the financial information given in Exhibit 2. The ratio is calculated to be 51.61%. Using the Formula, the beta is estimated to be 1.31.
Â | Actuant Corp. | Briggs & Stratton | Idex Corp. | Lincoln Electric | Snap On Inc. | Stanley Works | Robertson Tool Co. | |
Share Price | $ 42 | $ 42 | $ 29 | $ 22 | $ 26 | $ 27 | $ 30 | |
Earnings Per Share | 2.80 | 3.20 | 2.00 | 1.78 | 1.80 | 2.32 | 2.32 | |
Price/Earnings | 15.0 | 13.1 | 14.5 | 12.4 | 14.4 | 11.6 | 13.5 | |
Equity Beta | 1.00 | 1.00 | 1.00 | .75 | 1.05 | .95 | 1.05 | |
Asset Beta | 0.71 | 0.63 | 0.80 | 0.63 | 0.85 | 0.73 | ||
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Market risk premium was also given in case data, which is 5.5%. Risk free rate is taken as 4.10%, which is the 30-year U.S Treasury bill rate. The Capital Asset Pricing model is used to calculate the cost of equity for the firm. The formula is:
Cost of Equity= Rf+ beta*(Rm-Rf)
Where,
Rf= Risk Free rate
(Rm-Rf)= Market Risk Premium
The cost of equity is estimated to be 11.30%. Cost of debt is calculated using the financial information given for the firm. The interest expense for the year 2002 is divided over the total debt to get interest rate that is taken as cost of debt for the company, which is 6.7%.
The company has about 28% of debt in its capital structure and 72% of equity. Tax rate is taken same as used in the Pro-forma exhibit, which is 40%……………………….
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