Financial Management Assignment

Pre-read Assignment-1
of
Burton Sensors, Inc.

Submitted to

Prof. Kanagaraj Ayyalusamy

Submitted by

Section – A
Ankit Guleria (BJ22009), Mohit Singh (BJ22024), Nitish Bajaj (BJ22027), Rahul Jain (BJ22034)

Date

12/01/2023

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 BURTON SENSORS, INC.
Case Brief:

Burton sensors operate in the sensors industry which is a fragmented and competitive industry. To stay
competitive, Burton must design customized products and improve distribution networks. The overall
industry CAGR is expected to be 4.5% between 2017-23 while the fiber-optics sensors market is
expected to have a 15% CAGR.

Burton’s total liabilities are 5 times its net worth and outstanding bank as a ratio of the total value of
account receivables and inventory exceeded far beyond the industry norms. Due to this, the bank has
imposed two restrictions for future loans – outstanding loans to not exceed 75% of the company’s
accounts receivable and inventory; total liabilities should not exceed 3 times the book value of equity.

Burton should also decide whether to purchase more thermowell machines or not as it will demand
more resources and a sudden rise in average net working capital due to an increase in inventory arising
from in-house production.

Owing to the high number of existing debts and liabilities in Burton, raising additional capital through
private placement is an option to sustain projected sales growth. Acquisition of Electro-Engineering is
another avenue Burton Sensors is looking into. EE is a small manufacturer of fiber optics sensors and has
a stronger balance sheet. Acquiring EE will improve the current situation of Burton sensors.

Issue of the case/Problem statement:

The President, Amy Marshall, needs to decide on 3 issues listed below in the table:

S.No. Issue/Problem Statement Facts/arguments in discussion

1. Should Burton purchase a new
thermowell machine?
a. Purchase of 4 new thermowell machines for $6,00,000
b. Outsourced $1.4 million spent to be mfg. in-house
c. If purchased, Average net working capital to be
increased by $6,50,000 annually till the equipment life
maturity.

2. Should Burton raise additional To raise capital by selling 4,50,000 shares of the company
capital through a private @ $3.50 per share and additional 50,000 to the consulting
placement? firms.
3. Should Burton acquire Electro- Fiber Optic sensor market growing @CAGR of 15%- so is it
Engineering, Inc., which good to acquire 100% of small mfg. firm, in exchange of
manufactures fiber-optic the firm’s common stock.
sensors?
Other The outstanding loans not to be exceeded 75% of the company’s inventory and a/c
concerns receivables from 96% at present.
Total Liabilities not to be exceeded beyond 3*book value of equity, which is at 5 times
currently.

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Problem Analysis:

• Should Burton purchase a new thermowell machine?

Firstly, the firm’s average beta is computed using the unlevered beta of the 4 companies given
in the exhibit, which is further multiplied with company’s D/E ratio. Then, WACC is computed as
shown in the table.

Calculation of Beta
Particulars TEL Ametek Opsens Cyberoptics Average Burton
Equity/Capital 69.18% 68.34% 77.22% 100.00% 71.58% 19.61%
Debt/Capital 30.82% 31.66% 22.78% 0.00% 28.42% 80.39%
Debt/Equity 44.55% 46.33% 29.49% 0.00% 40.13% 410.00%
Tax Rate 35.00% 35.00% 35.00% 35.00% 35.00% 35.00%
Levered Beta 1.24 1.25 1.02 0.85 1.09 3.32
Unlevered Beta 0.96 0.96 0.86 0.85 0.91

Calculation of WACC
10-year US Treasury Note Yield 3.00%
Equity Risk Premium 5.80%
Beta 3.32

Cost of Equity 22.28%

Cost of Debt 5.50%

Tax Rate 35%
After Tax Cost of Debt 3.6%

Debt in the capital structure 80.39%

Equity in the capital structure 19.61%
WACC 7.24%

Secondly, the net cash flow is computed using the cash inflows and the cash outflows post-
purchase of the machines. The cash flows are discounted for a period of 7 years @WACC
computed above.

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 Calculation of PV of Cash Flows from Buying Thermowell Machine
Particulars 2017 2018 2019 2020 2021 2022 2023
Cost Savings 1400000 1463000 1528835 1597633 1669526 1744655 1823164
Less: Salary of Operators 170000 170000 170000 170000 170000 170000 170000
Less: Material & Rent Expense 780000 780000 780000 780000 780000 780000 780000
Less: Depreciation 85714 85714 85714 85714 85714 85714 85714
Total Income 364285.7 427285.7 493120.7 561918.3 633811.8 708940.4 787449.9
Add: Depreciation 85714 85714 85714 85714 85714 85714 85714
Less: Taxes 97500 119550 142592.3 166671.4 191834.1 218129.1 245607.5
Net Cash Inflow/(Outflow) 352500 393450 436243 480961 527692 576526 627557
Incremental Working Capital
Released 650000
PV of Cash Inflow/(Outflow) 328693.3 342100 353690.6 363611.1 371996.9 378973.8 783074

Finally, the Net present value came out to be positive and the internal rate of return to be
greater than WACC, which helps us conclude that the Burton should purchase the machines.

Calculation of NPV and IRR

Total PV of Cash Inflow/(Outflow) 2922140
Cost of Thermowell Machine 600000
Working Capital Investment 650000
NPV of Buying Thermowell
Machines 1672140
IRR 18.8%

• Should Burton raise additional capital through a private placement?

Considering that the additional capital is raised through equity financing, we have carried out
the following analysis:
Covenant 1: Bank loans and (AR + Inventory) are taken from Exhibits (provided in the case) and
the excess bank loan is calculated. The cash proceeds from the equity issue (450000 shares x
$3.5/1000) are calculated. Therefore, we have checked whether the cash proceeds are sufficient
to repay the excess bank loan.

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 Covenant - 1
Particular 2016A 2017E

Bank Loans 4,580 5,080

AR + Inventory 4,751 5,823

Bank Loan % 96% 87%
Target Ratio 75%

Target Bank Loan 4,367

Required Repayment 713

Cash Proceeds from Equity
Issue 1,575
Covenant 2: After issuing common stock, the liability and equity ratio is estimated for the year
2017 based on the values given in exhibits and the changed capital structure. We have observed
that the ratio improves y-o-y when the stock are issued.

Covenant - 2
2016 2017
Particular
Existing Structure Existing Structure Post Issue Structure
Total Liability 8,537 9386.4 9386.4
Total Equity 1,546 2116.8 3866.8
Liability/Equity 5.5 4.4 2.4

• Should Burton acquire Electro-Engineering, Inc., which manufactures fiber-optic sensors?

We ran DCF analysis to make the acquisition decision. Firstly, We calculated WACC for EE as
shown in the table with Beta being computed in the same way as in problem statement 1.

WACC Calculation
Debt 310.6
Equity 1429.6
Tax Rate 0.35
Finance Costs (as per P&L
statement) 18.7

Calculating Cost of Debt 3.57%

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 Calculating Cost of Equity
Beta 1.04
Risk Free Rate 3%
Market Return 8.8%
Equity Risk Premium 5.8%

Ke (Cost of equity) 9.00%

Wd 17.85%
We 82.15%

WACC 8.03%
Terminal Growth Rate 1.25%

The terminal value has been assumed to be 1.25%. Secondly, we computed the P/L statement
data for next 5 years using last 3 years average as a percentage of sales, which are discounted
@WACC computed above.

PBT Calcuation
Particulars 2014A 2015A 2016A 2017E 2018E 2019E 2020E 2021E
Net sales 2944.90 3566.30 4072.70 5050.15 5933.92 6824.01 7642.89 8407.18
COGS 1525.00 1811.70 2085.20 2474.57 2907.62 3343.77 3745.02 4119.52
Gross profit 1420.00 1754.60 1987.50 2575.58 3026.30 3480.25 3897.88 4287.66
SG&A expense 814.90 930.10 1080.90 1204.97 1415.83 1628.21 1823.59 2005.95
R&D expense 153.10 178.30 219.90 262.57 308.53 359.35 399.08 439.61
Depreciation and
amortization 142.20 196.90 206.10 259.41 182.55 209.04 237.94 245.83
Interest expense 18.70 18.70 18.70 18.70 18.70 18.70 18.70 18.70
Pretax income (loss) 291.00 430.60 461.80 829.87 1100.64 1264.89 1418.51 1577.51
Income taxes 101.80 150.70 161.60 290.46 385.22 442.71 496.48 552.13
Net income 189.10 279.90 300.20 539.42 715.41 822.18 922.03 1025.38
Number of common
shares (thousands) 1100.00 1100.00 1100.00 1100 1100 1100 1100 1100
Earnings per share 17.00 0.25 0.27 0.49 0.65 0.75 0.84 0.93

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 FCFF Valuation
Particulars 2014A 2015A 2016A 2017E 2018E 2019E 2020E 2021E
Net Income 189.10 430.6 461.8 539.42 715.41 822.18 922.03 1025.38
Add: Depreciation 142.20 196.90 206.10 259.41 182.55 209.04 237.94 245.83
Add: Interest 18.70 18.70 18.70 18.70 18.70 18.70 18.70 18.70
Tax 35% 35% 35% 35% 35% 35% 35% 35%
Less: Capital Expenditure 230.3 287.1 346.6 288.0 307.2 313.9 303.1 308.1
Less: Changes in
Working Capital -78.5 216.2 318.6 152.1 229.0 233.2 204.8 222.3
FCFF 191.66 136.36 14.85 370.89 373.92 496.21 664.30 752.98
PV of FCFF 343.31 320.37 393.54 487.68 511.66

The analysis showed that an enterprise value of $7245000, which is greater than the offer
$6867000 worth 1445000 shares approximately. Hence, we should acquire the Electro-
Engineering, Inc.

Terminal Value 7636.87

PV of Terminal Value 5189.43
Enterprise Value 7245.99

Conclusion:

Based on the analysis, we conclude that:

a.) Yes, Burton should purchase the machines.

b.) Yes, Burton should raise capital through private placement.

c.) Yes, Burton should acquire Electro-Engineering

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