Flinder Valves and Controls Inc. Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

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 rate	40%
Growth Rate	4.8%
Discount Rate	7.2%
Shares Outstanding	2,440,000
Share Price	$ 39.75
Market Capitalization	$ 6,990,000

	Current	Forecasted
Free Cash Flow	2007	2008	2009	2010	2011	2012	TV
EBIT	9,612	12,412	13,390	14,820	16,510	18,460
Less: Taxes	4,037	4,965	5,356	5,928	6,604	7,384
NOPAT	5,575	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 FCF		2916	4295	4408	4597	4844	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 rate		40%
Growth Rate		4.8%
Discount Rate		7.2%
Shares Outstanding		2,440,000

					Worst Case Scenario
		Actual			Projected
		2007			2008		2009		2010		2011		2012
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
		Actual			Projected
		2007			2008		2009		2010		2011		2012
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 Scenario	Current		Fore casted
Free Cash Flow	2007		2008	2009		2010		2011		2012		TV
EBIT	9,612		10,562	11,619		12,778		14,059		15,465
Less: Taxes	4,037		4,225	4,647		5,111		5,624		6,186
NOPAT	5,575		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 FCF			1881	3370		3413		3484		3575		148,954.11

Intrinsic Value
Enterprise Value	164,677
Equity Value	164,677,198
Equity Value/Share	$ 67.49

Best Scenario	Current		Fore casted
Free Cash Flow	2007		2008	2009		2010		2011		2012		TV
EBIT	9,612		13,918	19,103		25,301		32,691		41,464
Less: Taxes	4,037		5,567	7,641		10,120		13,077		16,585
NOPAT	5,575		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			4,030	8,364		11,719		15,780		20,660
Terminal Value												860,842.11
PV of FCF			3759	7278		9512		11949		14594		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

	2003	2004	2005	2006	2007
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 income	5,184	5,275	5,188	6,259	5,575

Cash dividends	1,680	2,008	2,016	2,304	2,304
Depreciation	784	924	1,088	1,280	1,508
Capital expenditures	1,486	1,826	2,011	2,213	2,433
Working capital needs	1,899	3,492	-1,200	4,289	4,757

FCF	5,968	6,199	6,276	7,539	7,083
% Change		3.87%	1.24%	20.12%	-6.05%
Growth rate	4.80%

	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 rate	40%
Growth Rate	4.8%
Discount Rate	7.2%
Shares Outstanding	2,440,000
Share Price	$ 39.75
Market Capitalization	$ 96,990,000

	Current	Fore casted
Free Cash Flow	2007	2008	2009	2010	2011	2012	TV
EBIT	9,612	10,186	10,740	11,325	11,941	12,591
Less: Taxes	4,037	4,074	4,296	4,530	4,776	5,036
NOPAT	5,575	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 FCF		1670	2912	2705	2521	2357	98,196.97


Intrinsic Value
Enterprise Value	110,362
Equity Value	110,362,332
Equity Value/Share	$ 45.23