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# Case: John Case Company

## FIN 4870: Strategic Finance

November 3, 2003
1. Based on the current expectations Mr. Case can be seen as requesting a premium
for his company. Using various comparable multiples and discount cash flow analysis
the company’s value falls between \$9.27 and \$17.42 million with an overall expected
value closer to \$17 million. The following table outlines the valuation based on
comparable company market values to earnings and sales which provide average
multiples of .61 (market value to sales) and 9.31 (market value to earnings) to value the
John Case Company. Based on these multiples the John Case is valued at \$9.269 million
against sales (.61 * \$15.260 million) and \$18.301 million against earnings (9.31 * \$1.966
million)
DeLuther Wakefield Officomp
Shares outstanding 425.00 310.00 555.00
Share price \$ 22.25 \$ 14.75 \$ 29.25
Market value \$ 9,456 \$ 4,573 \$ 16,234

## Sales \$ 16,427.0 \$ 12,223.0 \$ 18,608.0

Multiple 0.58 0.37 0.87
Earnings \$ 1,051.0 \$ 501.0 \$ 1,656.0
Multiple 9.00 9.13 9.80

On a standard EBITDA multiple basis the company’s value falls in a tighter range
between \$10.752 and \$16.128 million for a multiple of 4x and 6x respectively. The
following table breaks down this valuation. While this is not an exact method of valuing
the company the multiples are common for the buyout industry and can be expected to
provide a value similar to what a third party might expect.

## 1984 Multiple Implied Value

Gross profit 5962 4x \$ 10,752
S, G & A -3274 5x \$ 13,440
EBITDA 2688 6x \$ 16,128

A discounted cash flow model provides the highest value for the John Case
Company of \$17.42 million. This value is based on cash flows between 1995 and 1990
with the effects of financing added back to the projected cash flows. The terminal value
is calculated on 1990 cash flow with a 5% growth rate. The cost of debt (18%1) provides
1
The cost of debt is calculated using a post-purchase capital structure. Since the only debt added to the
company is for the purchase and will be stripped out in the DCF calculation the cost of debt is not included
a 21% approximate cost of equity (assuming a 3% premium over debt). Using this as our
discount rate the terminal value is \$7.357 million and an overall value of \$17.42 million.
The following table shows the numbers used to calculate the final value

## 1985 1986 1987 1988 1989 1990

Available for debt payments 1,448 1,702 1,920 2,114 1,982 2,002
Debt financing adjustment 1,675 1,538 1,369 908 800 800
Cash flow excluding financing \$ 3,123 \$ 3,240 \$ 3,289 \$ 3,022 \$ 2,782 \$ 2,802
Terminal value 5% growth 7,357
DCF valutation \$ 17,420

## Cost of equity 21%

Cost of debt 18%

2. Currently, the remaining \$3.5 million can be financed through current cash
reserves. Should the management team look to the venture capitalists for the additional
money at the same terms as the original \$6 million investment the company will be more
cash flexible in the short run as cash reserves are not reduced, but will give up longer
term dollars and short term working capital flexibility to pay off the VC group. With the
management team receiving the full \$9.5 million from the VC group the coupon
payments will increase from \$540,000 (\$6.0 million * 9%) to \$855,000. This additional
\$405,000 annual payment will have no direct effect on working capital accounts and
therefore will not adversely affect the company’s ability to operate within covenant
requirements.
For the VC group to realize the required 25% IRR for the project in addition to
receiving a 9% coupon the management team will have to pay out a \$13.447 million in
1991. This amount is \$7.84 million less (see the following tables) than if the
management team were to turn to the VC group for the entire \$9.5 million financing
shortage versus taking cash out up front. Since all free cash flows are projected to be
paid out in the form of debt service there will be no ability for the company to pay the
required \$21.2 million without taking out a term loan.

in the WACC calculation, but does provide a base for the cost of equity.
1985 1986 1987 1988 1989 1990 1991
Initial Investment \$ 6,000 (540) (540) (540) (540) (540) (540)
Present Value \$ (1,594)
Recovery balance \$ 4,406
Future Value \$ 13,447

## Interest Rate 9.0%

Required IRR 25.0%

## 1985 1986 1987 1988 1989 1990 1991

Initial Investment \$ 9,500 (855) (855) (855) (855) (855) (855)
Present Value \$ (2,523)
Recovery balance \$ 6,977
Future Value \$ 21,291

## Interest Rate 9.0%

Required IRR 25.0%

3. The management team can feasibly reduce the venture capital financing amount
by \$1.5 million to \$4.5 million and still keep their covenant agreements. However, by
doing this the company will bring cash reserves to below one million dollars which may
be too aggressive for the management team and too small an amount to remain
operationally flexible. The following table illustrates the annual working capital accounts
projected by this scenario. 2 However, under this scenario the company may run into a
situation where additional financing is required. Under the current covenants the
company may not increase debt. This restriction must be lifted in order for the company
to remain financially flexible.

Working capital balances 1984 1985 1986 1987 1988 1989 1990
Cash \$ 5,762 \$ 762 \$ 762 \$ 762 \$ 762 \$ 762 \$ 762
Accounts receivable 2,540 2,667 2,804 2,944 3,091 3,245 3,408
Inventories 588 436 458 481 505 530 557
Current liabilities (1,266) (836) (901) (963) (1,038) (1,113) (1,174)
Net working capital \$ 7,624 \$ 3,029 \$ 3,123 \$ 3,224 \$ 3,319 \$ 3,425 \$ 3,552

2
Assume: 60.8 days receivables; 23.1 days inventory; 4.2 days prepaid expenses; 25.7 days payables; and
14.4 days accrued expenses. See balance sheet in appendix.
4. By receiving 4% coupon payments and receiving early payments in 1988 and
1989 Mr. Case will realize a 14.14% IRR and a 12.81% return under if the note is paid
off at maturity.
1985 1986 1987 1988 1989 1990 IRR
(4000) 240 240 1186 4766 14.14%
(4000) 240 240 240 240 6000 12.81%

Interest rate 4%

5. By increasing the market value of the firm by the projected revenue growth rates
the total value in 1991 is \$26.831 million. With a \$4.5 million initial investment and 9%
coupon payments the venture capital group will expect \$10.409 million to secure a 25%
return. As a percentage of the overall corporate value this represents a 38.8% ownership
position.
1985 1986 1987 1988 1989 1990 1991
Enterprise value growth rate 5.0% 5.1% 5.0% 5.0% 5.0% 5.0%
Implied Value \$ 20,000 21,001 22,076 23,180 24,338 25,554 26,831
Initial Investment \$ 4,500 (405) (405) (405) (405) (405) -
Present Value \$ (1,089)
Recovery Balance \$ 3,411
Future Value \$ 10,409
Ownership Requirement 38.80%

## Interest Rate 9.0%

Required IRR 25.0%

6. The projected new project will not be a good fit for the company under the new
management team. From a financial perspective the new project will require an
additional working capital outlay and other development and merchandising expenses in
an already stretched company. While the projected growth rate looks strong the 6%
margin is tight and will not be profitable should the revenues not materialize. The
possibility that expected revenues would not materialize is high as the competition is
stronger than in the current business and repeat business has to be consistently pursued.
Given the buyout situation the addition of this product line will take management’s time
and energy away from the core business at a time when the company can not afford a
misstep in operations.