In the summer of 2010, smidgeon industries was evaluating whether or not to purc
ID: 2705746 • Letter: I
Question
In the summer of 2010, smidgeon industries was evaluating whether or not to purchase one of its suppliers, the supplier, Carswell Manufacturing, provides Smidgeon with the raw steel Smidgeon uses to fabricate utility trailers. One of the first things that Smidgeon
In the summer of 2010, smidgeon industries was evaluating whether or not to purchase one of its suppliers, the supplier, Carswell Manufacturing, provides Smidgeon with the raw steel Smidgeon uses to fabricate utility trailers. One of the first things that Smidgeon's management did was to forecast the cash flows of Carswell for the next five years: Next, Smidgeon's management team looked at a group of similar firms and estimated Carswell's cost of capital to be 15%. Finally, they estimated that Carswell would be worth approximately six times its year 5 cash flow in fine years. What is your etimate of the enterprise value of Carswell? What is the value of the equity of Carswell if the acquisition goes through and Smidgeon borrows $2,4 million and finances the remainder using equity?Explanation / Answer
Enterprise value in 5 years = 6 * yr 5 cashflow = 6*1,258,608 = 7,551,648
We need to discount each of the yearly cashflows by 15% and also discount the year 5 enterprise value by 15%.
Current enterprise value = 1,200,000/1.15^1 + 1,260,000/1.15^2 + 1,323,000/1.15^3 + 1,389,150/1.15^4 + 1,258,608/1.15^5 + 7,551,648/1.15^5 = 8,040,619
Value of equity = enterprise value - debt = 8,040,619-2,400,000 = 5,640,619
Hope this helped ! Let me know in case of any queries.