Flinder Valves and Controls Inc. Harvard Case Solution & Analysis

Question-4:

The benefits and the risks associated with RSE’s merger with FVC was that RSE would gain synergistic edge due to the expertise that FVC had in their engineering field while ensuring that RSE would be able to diversify its operations as well. The kind of machinery and strength RSE had to support FVC and grow it, was substantial therefore by merging with FVC, Elliot was actually investing in that firm to grow it and in turn increase its cash flows as well. The other point under consideration was the contract that FVC was negotiating with the US Government which could prove to be very fruitful for RSE in the future. This is why FVC grabbed Elliot’s attention for it to be acquired while giving them the opportunity to diversify their operations and increasing their cash flows. Although the risks were the high incentives provided to Flinder and his likely retirement which was near in a few years.

The issues with the use of RSE International Scrip was that FVC would end up acquiring many of the shares of RSE since Auden company was already informed of that they will sell the shares of RSE as they won’t be interested in keeping the minority interest. If these shares are also purchased by FVC then they might gain substantial voting rights in RSE.

The relationship between RSE and Auden Company seems to be neutral. It’s just that Auden Company was a sales distribution channel which was generating 15% sales for FVC over the years and later on owned 20% rights of the company. It was Auden Company that pushed the proposal for merger in the market.

As substantial uncertainty regarding the potential benefits of new military technology ‘Gyre’ was prevailing in the market, Bill Flinders was not able to anticipate the benefit of this technology. But this technology was considered as a prime nature with high value of commercialization because other companies were performing research and experimental work at that time when Flinders was going to develop this. It was Elliot who had anticipated investing in the research and development of this technology to achieve potential gains out of it. Since this technology was developed by FVC and RSE was going to push this research further therefore the benefits would be equally distributed among both the companies. But the point to be noted here is that after acquiring FVC, RSE would be sole party for availing the benefits of this technology but it would transfer certain benefits to FVC in the form of bonuses and shares.

Exhibit 1: DCF Valuation

 

Assumptions
Tax rate40%
Growth Rate4.8%
Discount Rate7.2%
Shares Outstanding2,440,000
Share Price $             39.75
Market Capitalization $     6,990,000
CurrentForecasted
Free Cash Flow200720082009201020112012TV
EBIT 9,612    12,412    13,390    14,820    16,510    18,460
Less: Taxes4,037      4,965      5,356      5,928      6,604      7,384
NOPAT5,575      7,447      8,034      8,892      9,906    11,076
Add: Depreciation and Amortization      1,660      1,828      2,012      2,212      2,432
Less: Change in Net Working Capital      3,491      2,184      2,456      2,729      3,002
Less: CAPEX      2,490      2,742      3,018      3,318      3,648
FCF     3,126     4,936     5,430     6,071     6,858
Terminal Value    285,750
   
PV of FCF29164295440845974844   201,842
Intrinsic Value
Enterprise Value             222,903
Equity Value   222,902,832.84
Equity Value/Share  $                   91.35

Exhibit-2: Sensitivity Analysis

Assumptions
Tax rate40%
Growth Rate4.8%
Discount Rate7.2%
Shares Outstanding2,440,000
Worst Case Scenario
 ActualProjected
200720082009201020112012
Sales (increase by 10%)$49,364$54,300$59,730$65,703$72,274$79,501
Cost of goods sold (increase by 10%)        37,044    40,748    44,823    49,306    54,236      59,660
Gross profit        12,320   13,552   14,907   16,398   18,038     19,841
Selling, general, and administrative (increase by 10%)          2,936     3,230     3,553     3,908     4,299       4,728
Other income—net             228         240         264         288         320           352
Income before taxes          9,612   10,562   11,619   12,778   14,059     15,465
Taxes          4,037     4,225     4,647     5,111     5,624       6,186
Net income$5,575      6,337 $6,971 $7,667 $8,435 $9,279
Best Scenario
 ActualProjected
200720082009201020112012
Sales (increase by 15%)$49,364$56,769$65,284$75,076$86,338$99,289
Cost of goods sold (incease by 8%)        37,044    40,008    43,208    46,665    50,398      54,430
Gross profit        12,320   16,761   22,076   28,412   35,940     44,859
Selling, general, and administrative (incease by 5%)          2,936     3,083     3,237     3,399     3,569       3,747
Other income—net             228         240         264         288         320           352
Income before taxes          9,612   13,918   19,103   25,301   32,691     41,464
Taxes          4,037     5,567     7,641   10,120   13,077     16,585
Net income$5,575 $8,351 $11,462 $15,181 $19,615 $24,878
Worst Case ScenarioCurrentFore casted
Free Cash Flow200720082009201020112012TV
EBIT 9,612    10,562     11,619     12,778     14,059      15,465
Less: Taxes4,037      4,225      4,647      5,111      5,624        6,186
NOPAT5,575      6,337      6,971      7,667      8,435        9,279
Add: Depreciation and Amortization      1,660      1,828      2,012      2,212        2,432
Less: Change in Net Working Capital      3,491      2,184      2,456      2,729        3,002
Less: CAPEX      2,490      2,742      3,018      3,318        3,648
FCF 2,016 3,873 4,205 4,600 5,061
Terminal Value        210,875.65
PV of FCF18813370341334843575       148,954.11
Intrinsic Value
Enterprise Value        164,677
Equity Value   164,677,198
Equity Value/Share  $            67.49
Best ScenarioCurrentFore casted
Free Cash Flow200720082009201020112012TV
EBIT 9,612    13,918     19,103     25,301     32,691      41,464
Less: Taxes4,037      5,567      7,641     10,120     13,077      16,585
NOPAT5,575      8,351     11,462     15,181     19,615      24,878
Add: Depreciation and Amortization      1,660      1,828      2,012      2,212        2,432
Less: Change in Net Working Capital      3,491      2,184      2,456      2,729        3,002
Less: CAPEX      2,490      2,742      3,018      3,318        3,648
FCF 4,0308,36411,71915,78020,660
Terminal Value        860,842.11
PV of FCF3759727895121194914594       608,064.40
Intrinsic Value
Enterprise Value        655,156
Equity Value   655,156,286
Equity Value/Share  $          268.51

Exhibit-3: Re-Projections of Income Statement

20032004200520062007
Sales$36,312$34,984$35,252$45,116$49,364
Cost of goods sold      25,924       24,200       24,300       31,580       37,044
Gross profit      10,388      10,784      10,952      13,536      12,320
Selling, general, and administrative        2,020        2,100        2,252        2,628        2,936
Other income—net             92            572            108              72            228
Income before taxes        8,460        9,256        8,808      10,980        9,612
Taxes        3,276        3,981        3,620        4,721        4,037
Net income5,184 5,275 5,188 6,259 5,575
Cash dividends1,6802,0082,0162,3042,304
Depreciation7849241,0881,2801,508
Capital expenditures1,4861,8262,0112,2132,433
Working capital needs1,8993,492-1,2004,2894,757
FCF5,9686,1996,2767,5397,083
% Change3.87%1.24%20.12%-6.05%
Growth rate4.80%
Re-Projected Income Statement
        2,008         2,009         2,010         2,011         2,012
Sales      52,262      55,329      58,577      62,016      65,656
Cost of goods sold      39,259      41,607      44,095      46,732      49,526
Gross profit      13,002       13,722       14,482       15,284       16,130
Selling, general, and administrative        3,110        3,292        3,485        3,690        3,907
Other income—net           293           310           328           347           368
Income before taxes      10,186       10,740       11,325       11,941       12,591
Taxes        4,074        4,296        4,530        4,776        5,036
Net income        6,111         6,444         6,795         7,165         7,554

Exhibit-4: Re-calculation for Enterprise Value

Assumptions
Tax rate40%
Growth Rate4.8%
Discount Rate7.2%
Shares Outstanding2,440,000
Share Price $             39.75
Market Capitalization $     96,990,000
CurrentFore casted
Free Cash Flow200720082009201020112012TV
EBIT 9,612    10,186    10,740    11,325    11,941    12,591
Less: Taxes4,037      4,074      4,296      4,530      4,776      5,036
NOPAT5,575      6,111       6,444       6,795       7,165       7,554
Add: Depreciation and Amortization      1,660      1,828      2,012      2,212      2,432
Less: Change in Net Working Capital      3,491      2,184      2,456      2,729      3,002
Less: CAPEX      2,490      2,742      3,018      3,318      3,648
FCF     1,790     3,346     3,333     3,330     3,336
Terminal Value    139,018.32
   
PV of FCF16702912270525212357     98,196.97
Intrinsic Value
Enterprise Value             110,362
Equity Value         110,362,332
Equity Value/Share  $                   45.23

 

 

 

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