Eskimo pie earns revenues primarily through licensing, not a big manufacturer. Net income $4,000,000 Plus current interest expense less taxes (. X 67,000) 40,200 Plus: depreciation $1,352,000 Less: interest income from $13 mil.
Eskimo pie earns revenues primarily through licensing, not a big manufacturer. Net income $4,000,000 Plus current interest expense less taxes (. X 67,000) 40,200 Plus: depreciation $1,352,000 Less: interest income from $13 mil.
Eskimo pie earns revenues primarily through licensing, not a big manufacturer. Net income $4,000,000 Plus current interest expense less taxes (. X 67,000) 40,200 Plus: depreciation $1,352,000 Less: interest income from $13 mil.
Eskimo pie sells ice-cream and related food products
--earns revenues primarily through licensing, not a big manufacturer --key assets are brand name recognition --fragmented industry is consolidating, recent entry by large food cos.
Why was Reynolds selling Eskimo?
Why did Eskimo management prefer the IPO to the Nestle offer?
What criteria should Reynolds use in deciding between selling Eskimo to another firm versus taking Eskimo public in an IPO?
Valuing Eskimo Pie To value Eskimo we need the following: (1) An estimate of r WACC (2) An estimate of expected cash flows in 1991 (3) An estimate of the growth rate of future cash flows
Step 1: Estimating WACC
(A) Estimate unlevered : Use equity betas of stock in table 8, unlever them using the formula from chapter 12: equity = [1 + (1-T C )Debt/Equity] unlevered
equity
unlevered Ben & Jerrys 1.2 1.18 Dreyers 1.4 1.33 Empire of Carolina .3 0.14 Steves Ice Cream 2.5 2.37 Hershey Foods 1.0 0.96 Tootsie Roll 1.0 1.00
Average unlevered = 1.162, use this as our estimate. Estimating WACC (continued) (B) Estimate equity at the target D/E ratio What would Eskimos target capital structure be after IPO?
equity = unlevered = 1.162
(C) Identify r f Use 10 year bond yield from exhibit 9: 7.42%
(D) Identify the market risk premium r M -r f
Use 7.43% given in the problem.
(E) Use the CAPM to estimate r equity r equity = 7.42 + (1.162) x (7.43) = 16.05% Under the unlevered target capital structure, r WACC = r equity = 16.05%
Step 2. Expected cash flows Lets estimate year-end 1991 after-tax cash flows since the Exhibit 6 forecasts seem too low.
Net income $4,000,000 Plus current interest expense less taxes (.6 x 67,000) 40,200 Plus: depreciation $1,352,000
Less: interest income from $13 mil. Cash -$355,680 [$13 mil. paid out in the transaction Lost interest: $13mil. x (1-.4) x 4.56%]
Less: capital expenditures -$1,000,000 change in working capital 0
Total Expected Cash Flow at end of 1991 $4,036,520
Working capital changes Working capital excluding cash has decreased over the period 1987 to 1991, even though sales have increased.
Eskimo Pie is a marketing and licensing firm, not a manufacturer.
Would be reasonable to exclude working capital changes from cash flow estimation.
1987 1988 1989 1990 Working capital 9,342 11,107 10,830 11,735 Cash 5,550 8,109 10,723 13,191 Working capital less cash 3,792 2,998 107 -1,456 Step 2. Expected cash flows Lets estimate year-end 1991 after-tax cash flows since the Exhibit 6 forecasts seem too low.
Net income $4,000,000 Plus current interest expense less taxes (.6 x 67,000) 40,200 Plus: depreciation $1,352,000
Less: interest income from $13 mil. Cash -$355,680 [$13 mil. paid out in the transaction Lost interest: $13mil. x (1-.4) x 4.56%]
Less: capital expenditures -$1,000,000 change in working capital 0
Total Expected Cash Flow at end of 1991 $4,036,520
Step 3. Estimating a growth rate in future cash flows Eskimo Pie grows substantially in 1991, which made IPO a potential alternative.
One approach: Estimate average annual growth in sales
Question: Is this a reasonable estimate of expected cash flow growth? Has past 4-year period been special will growth slow down?
Other approaches to estimate growth
1. Past growth in net income 2. Past growth in operating income 3. Past growth in cash flows
Problem: These numbers are more variable, particularly for years with income or cash flows close to zero.
Bringing in more information What are analysts saying about future industry prospects?
What does Goldman-Sachs project? (forward looking estimates)
Expected 1992 growth in sales 4.54% Expected 1993 growth in sales 1.24% Average 2.89%
Expected 1992 growth in net income 10.44% Expected 1993 growth in net income 6.23% Average 8.34%
Net income more closely tracks changes in cash flow
Since growth is slowing down, lets use 6.23% for a constant growth rate.
4. Putting it all together
V = [Expected 1991 cash flow x (1+growth rate)] / [r growth rate]
V = [($4,036,520) x (1 + .0623)] / [.1605 - .0623]
V (or E) = 43,665,939
Should Reynolds sell to Nestle or do the IPO?
Nestle offer - $61 million cash
IPO proceeds Cash from stock sale $43,665,939 Special dividend payment of $15,000,000 Total $58,665,939
Looks like Nestle offer is slightly better.
Some Issues: Results very sensitive to assumptions about growth rates - If more optimistic since Goldman Sachs projection does not reflect the recent development. Use 8.34% (the average growth rate) Total proceeds would be $71,720,697.
Other methods of valuing stocks? How about other firms in the same industry?
Comparable public firm multiples There would be some multiples that could be used to check our estimates.
The value of Eskimo Pie would range from about $84 to $98 million (excluding the excess cash) our estimate seems to be undervalued.
Additional issues: Need to convince that IPO is feasible. Equity-to-net income Total value-to-sales Average of other firms 22.8 1.6 Estimate for Eskimo Pie 3.7 61 Implied value 84.4 97.6