The Tandean Rustandy Company Harvard Case Solution & Analysis

Part 4

A.     Adjusted income statement, balance sheet and free cash flows of Knee Mark Stores

Knee Mark Stores (KMS) experienced a fire in its primary distribution factory, which significantly threatens the shipping and distribution cost because the company was directly shipping to stores from many of their suppliers. Further, the company charges the incremental shipping and distribution cost to selling, general and administration expenses, so in order to eliminate one-off practice, adjusted income statement, balance sheet and cash flows have been calculated to facilitate effective valuation of the firm.

The adjustment for selling, administration and general expenses increases the operating income from $288.5 million to $588.5 million and net income from $159.6 million to $354.6 million because it has been assumed that adjustment for shipping and distribution cost increase the operating profit; hence, it is susceptible to increased tax expense. Further, the adjustment also affects the retained earnings from $1562.9 million to $1757.9 million.

The cash balance in the balance sheet has been adjusted for adjustment in selling and distribution expenses and operating liabilities have been adjusted for increased liability due to increased tax expense. Further, it resulted a change in tax adjusted EBIT from $489.4 million to $684.5 million but no changes has been resulted in adjusted free cash flows because adjustment in selling and distribution expenses results a corresponding entries in cash and other liabilities, which set-off the adjustments.

B.     Valuation using market multiple valuation technique

Valuation multiples of Knee Mark Stores (KMS) has been calculated to value the Tandean Rustandy Company. The firm’s value of KMS at year 0 amounts to $5,600 million and it has been calculated by deducting the market value of debt and preferred stock from the common value of equity. Multiple has been calculated for revenue, EBITDA, EBIT, tax adjusted EBIT and unlevered that amounts to 0.90, 6.29, 9.52, 8.81 and -43.83 respectively.

Valuation using different multiples of revenue, EBITDA, EBIT, tax adjusted EBIT and unlevered cash flows amounts to $3,702 million, $4,662 million, $5,287 million, $4,477 million and $-9,744 million, which provides an average valuation of $4,532 million.

Valuation using Discounted Cash Flow (DCF) technique provides valuation of $6,882 million; whereas, market multiple valuation technique provides the average valuation of $4,532 million, so the organization shall consider to sell the business at an increased price of $6,882 and if the buyer resembles then the organization shall not consider to sell the business less than $4,532 million.

C.     Implied market multiple using valuation date at Year 0, Year 5 and Year 10

Enterprise value of Tandean Rustandy Company for the Year 0, Year 5 and Year 10 has been calculated in Appendix 9, which provides the value of $3,733 million, $799 million and $7,006.79 million. The enterprise value has been calculated by determining free cash flows for Year 0, Year 5 and Year 10 with corresponding increase cash flows that will continue till perpetuity. In determining the terminal value, growth rate of 2% has been assumed.

There is a substantial difference in enterprise value for the three years because the company is considering to invest heavily in non-current assets, which will increase operating activities of the company and tend them to generate highest revenues in future. Further, enterprise value based on year 5 is substantially low because in year 5 the company has invested heavily on non-current assets and working capital that substantially threatens the cash flows of year 5 and also the terminal value based on such period.

Our analysis in Appendix 9, shows that implied multiple for year 0 represents 0.91, 5.04, 6.72, 10.33 and 16.79. Further, year 5 represents 0.12, 0.69, 0.93, 0.93 and 66.58 and year 10 represents 0.78, 4.33, 5.48, 8.43 and 9.73 for EV/revenue, EV/EBITDA, EV/EBIT, EV/Tax adjusted EBIT and EV/Unlevered FCF

D.     PV of company’s leases for Year -1 and Year 0 and rent expense for Year 0

Present Value (PV) of the company’s lease for the year 1 and year 0 has been calculated in Appendix 10, which amounts to a total of $1,172.46 million and $1,263.35 million respectively. It has been calculated by discounting the lease payments over the period in which it is expected to be paid and the discounted figures are later on summed up to determine the present value of lease. Further, risk adjusted discount rate for lease is assumed to 5%, which equals to cost of debt of unsecured debts...........................................

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