discounted cash flow valuation method

| September 28, 2018

You have been hired as the strategic analyst in the Sbios Group of company and have been asked to examine the potential takeover of Mbios Plc, a competing firm in the same gadget industry sector.Financial information of Mbios Plc is given below:Mbios PlcIncome Statement Last Yr Current Yrin £ mill in £ millSales 470 482Cost of Sales (236.0) (274.0)Gross margin 234 208.0Sales, general and admin expneses (56.0) (72.0)Research and Dev (22.0) (26.0)156.0 110.0Depreciation (30.0) (32.0)Profit before interest and tax 126.0 78.0Interest (14.0) (12.0)Profit before tax 112.0 66.0Tax (34.0) (20.0)Net Profit 78.0 46.0Balance Sheet Last Yr 31st Dec Current Yr 31st Decin £ mill in £ millFixed asset 250 264Current asset 170 184Total 420 448Current liabilities 120 132Amounts falling due after one year 70 70Shareholder’s funds 230 246420 448Number of outstanding shares (In Million) 152Share Price (£) 24.2 21You have now identified following information that you need to consider when valuing Mbios PlcSome production process are similar. You have identified an overlap process between Sbios and Mbios that would allow to immediately closedown part of Mbios manufacturing process. You estimate that it will cut the book assets at Mbios by a third but at the same time the rationalisation would not affect sales. The realisable value of the asset disposals, which would occur in the first year of the acquisition, would be £42 million after tax.You expect to raise Mbios’s gross margin from its current level to 45% in year 1 of the acquisition and then to 50% in year 2 and subsequent years as part of the benefit from rationalisation and greater efficiencies from the merger.You expect Mbios’s sales to grow at 6% in the future as a result of synergistic benefits derived from the takeover and a recovery in the market for Mbios’s products as well as the introduction of new products.You anticipate that investment in new fixed assets would be 5% of sales in any given period. Depreciation is 10 % of the book value of fixed assets.You anticipate being able to eliminate the research and development spend at Mbios post acquitision as development of new products is integrated with Sbios. There would be no increase in Sbios’s R&D budget from this change.Sales, general and other administrative expenses are projected to be 10% of sales in all subsequent yearsYou anticipate that current assets would be 37% of sales in any year and current liabilities 25% of sales in any given yearThe corporate tax rate is 30%The WACC used for internal projects at Sbios Plc is 10% after taxOnce the steady state following the acquisition has been achieved, for valuation purposes, all future cash flows beyond the detailed cash flow modelling period will be determined using a multiple of 5 times cash flow. Note that the steady state at Mbios occurs in year 3 following the acquisition.QuestionUsing discounted cash flow valuation method, find out the value that Papple should pay for the proposed acquisition and comment on the results?All working notes should be written clearly along with justification for any assumption made.

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