Calaveras Vineyard Harvard Case Solution & Analysis

Q5: What is the NPV of the free cash flows from Q3 above?  What growth rate in perpetuity did you use and why? What is the remaining equity value after subtracting the required investment at closing?

The net present value model is used to calculate the value of a firm on a going concern basis; hence, this valuation model uses the free cash flows generated by the company. Hence, for the valuation of Calaveras free cash flows as calculated above has been used in order to arrive at the value of Calaveras on a going concern basis. However, the cash flows calculated above are for a period of five years, but since the valuation is an ongoing concern basis, which means that the business will keep on generating revenue even after the year five. Therefore, terminal values need to be calculated, in order to incorporate the value of cash flows generated by Calaveras after year five, however, since the future is uncertain and the terminal values would represent the value of cash flows till infinity, therefore, the validity and reasonability of terminal values depend on the growth rate at which the terminal values of cash flows after year 5 will be calculated.

Meanwhile, since the future values will be subject to inflation in the market and growth rate at which the future revenues of Calaveras are expected to grow, hence, the future terminal values are expected to grow at a rate of 2% which is the average of inflation rate and real growth rate. However, based on the analysis of net present value model the value of Calaveras on going concern basis has been calculated at $7,802,730/-, meanwhile, the required investment as provided in the case is $4,122,000/-, therefore, the remaining equity value relating to the equity holders of Calaveras would be at $3,680,730/-

Q6: What is the liquidation value of the company and how does it compare to the debt to be taken out at closing?

Valuation of a company on a liquidation basis means that the assets of business would be sold on a piecemeal basis and the resulting proceeds would first be used to pay off any outstanding debt at the date of liquidation. Meanwhile, the residual value of the sales proceeds would be attributable to the equity holders and that residual would be known as the value of a company on liquidation. However, in case of Calaveras the total assets of the company at the end of year 1993 is assumed to be the sales value of Calaveras, however, since the balance sheet item are recorded on cost and the market value of the item is not recorded, hence, it is probable that some of the balance sheet items would not be sold at their book values.

Therefore, Clemens has estimated that only 40% of the net book value of plant and equipment would be recoverable, meanwhile, the inventory and receivables would only be able to realize 75% and 85% of their book values. Therefore, after incorporation of Clemens’ estimation the    values of Calaveras would be $3.394,637/-, meanwhile, then as a result of the deduction of required investment at closing would lead to a negative equity value for Calaveras on a liquidation basis at the end of year 1993.

Q7: Would you say Calaveras would be a creditworthy borrower?  Why or why not?  Show appropriate financial ratios and also discuss the 5C’s of credit to support your conclusion.  See credit analysis template.

However, considering the liquidity position of Calaveras, it can clearly be seen that the current ratios of Calaveras are quite below the industry ratios and they even do not meet the lower quartile of the industry ratio, further, the quick ratio hardly meets the lower quartile but still it is below the average industry ratios. Meanwhile, the current liabilities and total liabilities to equity ratio is very much higher in comparison to the industry levels, which means that Calaveras is highly geared and uses high level of debt financing in comparison to the equity portion, in addition to this the high level of liabilities as percentage of equity means that Calaveras is already committed to high level of interest payments and further debt financing would mean that commitment to additional interest payments that would be quite difficult to manage by Calaveras.

However, the situation would turn into the favor of Calaveras in the year 1998, additionally, the profitability ratios are above the industry's upper quartile, which ensures that the commitment of management towards the improvements in Calaveras operations and would become a financially sound company with improved liquidity through the use of non recourse factorization for the collection of trade receivables...................................

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