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FIN 475 Fall 2013 Case Study: Flinder Valves and Controls Raul Zaragoza

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FINANCE 475
Flinder Valves and Controls, Inc.
1. In Exhibit 1, what percent of Flinders assets are financed with debt, and what percent is financed
with equity? (State your percentages with one digit to the right of the decimal point.)
Flinder Capital Structure
Assets financed with debt (1,000s) $5,360.00
Assets financed with equity (1,000s) $36,764.00
% of debt 12.7%
% of equity 87.3%



2. In Exhibit 3, what percent of RSEs assets are financed with debt, and what percent is financed
with equity? (Again, state one digit to the right of the decimal point.)

RSE Capital Structure
Assets financed with debt (1,000s) $350,088.00
Assets financed with equity (1,000s) $939,897.00
% of debt 29.3%
% of equity 70.7%


27.1%
72.9%
RSE Capital Structure
% of debt
% of equity
12.7%
87.3%
Flinder Capital Structure
% of debt
% of equity
FIN 475 Fall 2013 Case Study: Flinder Valves and Controls Raul Zaragoza

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3. Assume that RSEs cost of equity is 10%, its pre-tax cost of borrowing is 5%, and that its
marginal tax rate is 35%. Using RSEs capital structure found in question 2 above, what is RSEs
WACC?
RSE Cost Equity 10.0%
Pre-Tax Cost Debt 5.0%
Marginal Tax Rate 35.0%
After Tax Cost Debt 3.25%
RSE WACC 8.17%
WACC =
(10%*.729)+(3.25%*.271)




4. Now lets find the market value of RSE ( = PV of its cash flows, minus its total debt.) Using the
DCF (Discounted Cash Flow) method (also known as the present value method) for finding the
value for a stream of cash flows, what is the DCF value for (present value of) RSEs cash flows?
RSE Cash Flows 2008 2009 2010 2011 2012
Net Income $167,701.00 $166,237.00 $164,724.00

$171,098.00

$173,744.00
Plus Depreciation $27,950.00 $29,770.00 $31,700.00 $33,170.00 $35,960.00
Cash Flow $195,651.00 $196,007.00 $196,424.00

$204,268.00

$209,704.00
Average Cash
Flow $200,410.80 Starting in 2008 and Considered an On-Going Concern
PV of Future FCF $2,445,329.49

PV of Future FCF $2,445,329.49
Less RSE Total Debt ($377,871.00)
Appraised Market Value of RSE $2,067,458.49



FIN 475 Fall 2013 Case Study: Flinder Valves and Controls Raul Zaragoza

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5. Using the Capital Asset Pricing Model (CAPM), find the cost of equity for RSE.
a. For CAPM calculations, use the most recent three-month T-bill rate given in Exhibit 9.
b. Use the geometric average of the historical return premium of equity over government debt
for the period 1926-2007, as given in example 9.
c. For RSEs beta, use the average beta in Exhibit 7 showing similar firms.
d. Now that you have RSEs cost of equity, do you think this cost is too high, just about right,
or too low given the growth rate in 2007-2012 net income from exhibit 5? Explain why you
think so.
Risk Free Rate 4/08 1.28%
Geometric Avg. 5.5%
RSE's Beta 1.14375

RSE CAPM Cost of Equity 6.1%
CAPM = Rrf + B(Rm-Rrf)
Projected Growth Rate 2007-2012 5.91%

RSEs cost of equity per the Capital Asset Pricing Model is 6.1% and the firms projected
growth rate is 5.91%. As an investor, we should require a 6.1% rate of return. However, RSEs
projected growth rate is slightly lower than that, indicating that we are slightly overpaying for
their anticipated growth levels. While these numbers are fairly close I recommend that you keep
this in mind when negotiating the possible acquisition.







FIN 475 Fall 2013 Case Study: Flinder Valves and Controls Raul Zaragoza

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6. Merge FVC and RSE so that equal market values of stock and cash are exchanged. Your
exchange should include as little cash as possible. How many shares of RSE are necessary to
absorb all the outstanding shares of Flinder? Use the May 1, 2008, closing stock prices for both
firms, as found in Exhibit 6.
Market Cap Flinders FVC
Close Price per Share $39.75
Shares Outstanding 2,440,000
Market Cap Flinders $96,990,000

Market Cap RSE
Common Stock Close Price per Share $21.98
Common Shares Outstanding 62,694,361
Market Cap Common Shares $1,378,022,054.78
Preferred Shares Outstanding 1,389,160
Preferred to Common Conversion 1.24
Common Shares Post Conversion 1,722,558.40
Additional Market Cap $37,861,833.63
RSE Total Market Cap Post Conversion $1,415,883,888.41

Share to Share Conversion Chart Unrounded
1 RSE = $21.98 and 1 FVC = $39.75 1.8
1.80 * 2,440,000 (total FVC outstanding) 4,392,000
Additional Cash Needed Per Share $0.19
It would require 4,392,000 shares of RSE plus $0.19 per share
for RSE to acquire all shares of FVC.

1.80 * $21.98 = $39.56 value of 1.80 shares of RSE
$39.75 - $39.56 = $0.19 difference between 1.80 RSE and 1 FVC.
Depending on the rounding method used, the number of shares needed and the additional cash
needed per share a subject to incremental changes.