TSE International Corporation Case Solution
TSE International Corporation is one of the Fortune 500 companies founded in 1970 by Tom Eliot. There were many targets identified by TSE, Yeasts Valves was prominent among all. The reason for choosing Yeasts Valves is that it would offer efficient handling of small production orders and expertise in innovation-driven research &development to TSE International Corporation. The merger between these two companies requires a complete valuation analysis(using discounted cash flow model) of the buyer and target and negotiate an exchange ratio and price with counter party. Also, the case details the theoretical share that TSE would be willing to pay for Yeasts Valves.
The discounted cash flow model is one of the highly used financial models that values the company and provides the best estimates of the intrinsic value of the company’s stock (value based on the ability of the company to generate enough profit or cash flows in future).The depreciation is added back into the profit after tax, changes in working capital is incorporated and capital expenditure is deducted to calculate the free cash flow.Furthermore, the enterprise value of the firm on the basis of the free cash flow are calculated through using discounted free cash flows that provides more appropriate estimate of the company’s value. To discount back the calculated free cash flows of the company, the weighted average cost of capital (WACC) is calculated using the capital asset pricing model (CAPM).
Using the capital asset pricing model (CAPM), the discount rate is calculated 15%, while the terminal value and enterprise value is $74,276and $55013 respectively. The theoretical share price of YVC under DCF valuation and EV/EBITDA multiple assumption is $38.20 and $22.30.
Pros and Cons of Common-for-Common Stock Exchange and Cash Acquisition
The advantages and disadvantages of stock and cash offer acquisition are as follows;
Common-for-common stock exchange
There are multiple benefits to stock based transactions in which a TSE would use its stock as currency to acquire another company. One of the significant and inevitable advantage of stock offer acquisition is thatthe company could keep its cash reserves to exploit other growth opportunities. The acquirer of the company does not need to bother with retitles of individual assets and costly revaluation. The buyer is able to avoid to pay transfer taxes. In stock transaction, the risk tend to be allocated between the shareholders in respect to their proportion of stock. For the acquired company’s shareholders, there are also some benefits. As the company would be paid in stock instead of cash, the company could hold on that shares and in result defer any implication of capital gains that might result from such buyout. From the standpoint of risk, the stock transaction presents various problems. The risk is proportionately shared between acquired and acquiring company. Also, the stock transaction means that the control of direction of company is ceded to the buyer. In stock transaction, the company could obtain the new tax free shares, also after acquisition or merger closes, the company could have a taxable loss or gain.
The cash transaction is widely used due to its straightforward simplicity. The benefits of cash deal face fewer hurdles. The roles of the acquired and acquiring parties are clear cut, also the exchange of money for share tend to complete a simple ownership transfer. Using cash to acquire another company involves less risk because of the fact that the paid amount is certain and the cash does not fluctuate in value just like stock. The cash deal provides a benefit of guaranteed price of acquisition over the inconsistent price of stock. The cash transaction also prevents the ownership dilution and allow the company to maintain current status of ownership. The disadvantages includes the company spends its cash reserves which could potentially be used for capturing and exploiting future growth opportunities. The cash transaction also lead to debt problems in case the company finance the purchase with loans from banks. Increasing the debt amount could increase the annual interest payment of the company, hence creating cash flow concerns.
Capital Structure or Mode of Financing
The optimal capital structure is recommended to finance the acquisition transition. The optimal capital structure search for the lowest weighted average cost of capital, it is due to the reason that wealth of shareholder or company maximizes when the weighted average cost of capital minimizes. The mixture of the equity and debt should reduce the weighted average cost of capital. It is significantly important to replace some of expensive equity with cheap debt in order to lower the average…………
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