Cardomaine Seaway Inc. is looking to make a share bid for Laker Transportation's 20 million common shares. Laker is struggling to turn the company around and carry a debt at a market value of $30 million. Laker's cost of capital is 9%. Sales revenue for this year is expected to be $50 million and Cardomaine believes Laker will be increasing it by 5% annually for the next four. Operating expenses are 75% of sales revenue with depreciation expenses equalling investment in replacement assets. Income taxes can be estimated at 24% of operating income. The company has published plans of additional asset investment at $5 million this year, $5 million next year and $7 million in each of the following three years. Working capital is 30% of sales revenue and the company expects to drop this by $3.2 million this year with additional declines of $3.2 in each of the following four years. What price per share would Cardomaine offer Laker's shareholders that would leave them as well off as before?

Question

Quizplus · Accepted Answer

To determine the price per share that Cardomaine should offer, we need to calculate the present value of the expected future cash flows of Laker Transportation and subtract the existing debt. Then, we can divide this value by the number of common shares outstanding to get the price per share.

Step 1: Calculate Free Cash Flows
Year 0: -30 (debt)
Year 1: 
Sales revenue: 50 million
Operating expenses: 0.75 * 50 = 37.5 million
Depreciation: 50 million (assumed equal to investment in replacement assets)
EBIT: 12.5 million
Taxes: 0.24 * 12.5 = 3 million
NOPAT: 9.5 million
+ Depreciation: 50 million
- Capex: 5 million
- Working capital: 0.3 * 50 - 3.2 = 11.8 million
Free cash flow: 43.3 million
Years 2-5: 
Expected growth rate: 5%
Sales revenue: 50 * (1+0.05)^t, for t = 2, 3, 4, 5
Operating expenses: 0.75 * (50 * (1+0.05)^t)
Depreciation: 50 * (1+0.05)^t
EBIT: (50 * (1+0.05)^t) - (0.75 * 50 * (1+0.05)^t) - (50 * (1+0.05)^t) = (0.25 * 50 * (1+0.05)^t)
Taxes: 0.24 * (0.25 * 50 * (1+0.05)^t) = (0.06 * 50 * (1+0.05)^t)
NOPAT: (0.19 * 50 * (1+0.05)^t)
+ Depreciation: 50 * (1+0.05)^t
- Capex: 5 million
- Working capital: 0.3 * (50 * (1+0.05)^t) - 3.2 = (8.3 * (1+0.05)^t)
Free cash flow: (3.3 + 8.3) * (1+0.09)^(-t), for t = 2, 3, 4, 5

Step 2: Calculate Present Value of Free Cash Flows
PV of free cash flows = 43.3 + (11.6/1.09^2) + (11.6/1.09^3) + (11.6/1.09^4) + (11.6/1.09^5) = 72.4 million

Step 3: Divide by Common Shares and Add Debt
Price per share = (72.4 + 30) / 20 million = $5.71

However, we need to adjust this price to leave Laker's shareholders as well off as before. We can use the following formula:

Offer price per share = (V + D - D') / N
where V is the present value of free cash flows, D is the existing debt, D' is the new debt issued to fund the buyout, and N is the number of common shares outstanding.

We can re-arrange this formula to solve for D':

D' = V + D - (Offer price per share x N)

If we assume that Laker's shareholders want to receive the same value they would have gotten without the buyout, then we can set D' = 0 and solve for the offer price per share:

Offer price per share = (V + D) / N

Plugging in the values, we get:

Offer price per share = (72.4 + 30) / 20 million = $5.13

Therefore, the best choice is C) $4.13, which is the closest to $5.13.