STERLING HOUSEHOLD PRODUCTS COMPANY Case Solution
To calculate the terminal value, the last yearâ€™s information has been used. To calculate terminal value, free cash flows of year 2022 with 9 terminal values have been identified, which is $239,655 million. To identify its present value, terminal value has been discounted to WACC.
NET PRESENT VALUE OF FREE CASH FLOWS:
By calculating all free cash flows and discounting it by WACC that is 5.46%, we identified the net present value of base case. Under the assumptions, the project is generating net present value of $20.519 million, after subtracting the acquisition amount of 256 million. Hence, the project is generating high net present value in respect to the initial investment.
AMOUNT AND TIMING OF EXPANSION INVESTMENTS FCF THROUGH 2013-2022:
It is expected that the management of the company has planned expansion plan in the year 2013. The life of expansion project is 20 years and it is expected that the project will be generating cash flow for 19 years, that is it will start generating cash flows from year 2014.
It is expected that the expansion plan required $600,000 outflows in year 2013. It is assumed that the project will generate revenues/inflows from the growth percentage provided in the base case. It is estimated that an amount of $600,000 is under the head of capital expenditure and 600,000 will be required in each projected year as capital expenditure.
To identify the free cash flows of expansion period, some assumptions have been taken. And by applying these assumptions, the free cash flows of expansion plan are calculated. To calculate free cash flows, same methodology has been used that is under the base case scenario.
It is expected that terminal value is also calculated under the expansion plan. In order to calculate terminal value, the same method under the base case method has been used. The free cash flows of last year i.e. 2022 are used and multiplied by 9 which generated a terminal value of 77.615 million.
NPV OF THE FOLLOW UP ACQUISITION PLAN:
In order to get the net present value of the expansion plan, the free cash flow model is used. Firstly, free cash flows of all the respective years have been calculated then the discount factor assumed at WACC of 5.36% has been applied to identify the present value. The present value of cash flows is identified at 96 million dollars, then the initial investment valued at 60,000 has been deducted, resulting in a net present value of 36.622 million. In the net present value calculation, terminal value has also been calculated and discounted at WACC factor, to implement the factor of time value of money.
The combine value of the investment base plan and the expansion plan has been calculated at 57 million positive, which shows that the investment in new sector, medical and health care industry, is worth to be made. The net present value of base case is valued at $20 million, which means that it is worth to invest in the acquisition of Montagne. The acquisition price of 265 Million is beneficial for Sterling Company, as in return, the company will generate more cash flows, which will create additional value of shareholders. Hence, the acquisition plan is said to be financially acceptable.
The expansion plan is also beneficial for the company and is a value added plan. If the company can make 60 million dollars available through careful planning and cost cutting, expansion will increase companyâ€™s sales and marketing and will be very valuable to the company on non-financial grounds as well.
STRATEGIC ISSUES AND OPPORTUNITIES:
Some of the strategic issues are associated with the acquisitions. Some issues are also with the Sterling acquisition with Montagne. As sterling is the manufacturer of householdâ€™s products that includes soap, toilet things, laundry products, cosmetics etc. The acquisition is in an entirely different industry, which has so many risks involved with it. There may be new market threats that will make the acquisition unreliable as well as the demand of medical products will make it unattractive. However, the company is ingrowing stage but there is no information of the international markets for these medical products, in which Sterling sell its product under its brand name.
If Sterling will not be able to run this company, and will fail to get into this market, the existing brand name and the reputation of the company in the market will be lost. And it will affect its existing products sale as well as the market shares and shareholderâ€™s equity.
Moreover, health care products may require some sophisticated and protected area for manufacturing of such items, and the acquisition might result in losing its own strategy and market. Sterling is also not aware of the rules and regulations of such industry. Therefore, Sterling may take time to understand the industry and its environment…………………
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