Essay about Cash Flow Analysis

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1. Several factors have made Interco an attractive takeover target: 1) Interco’s stock is undervalued due to poor performance in the apparel and general merchandising divisions, which have weakened Interco’s valuation as a whole. 2) As stated by the equity analysts, Interco is an over capitalized company with potential to grow, which makes an acquisition easy to finance. 3) Interco is also a cash generative target for a potential acquirer as it generates approximately $0.10 of operating cash flow for every dollar of sales. 4) The company is also structured in a way that it could be broken up and sold into its constituent parts, which could prove to be worth more than the whole.
2. As a member of the Board of Interco, neither the
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o The projected operating margin of 6.4% is much higher than the recently declining trend of 7.3%, 5.5% and 2.5% for the last 3 years, respectively.
• Footwear division’s projected growth rate of 6.3% is significantly lower than the recent performance of 19% and 34% over the last two years respectively. Also, it is projected to be the lowest of the four divisions despite being the best performer recently.
• Terminal value multiples of 14x-16x seem high. The Board should ask for additional support to validate these assumptions
• Discount rate of 10-13%. 10% seems low given the corporate bond rates and the risk free rates given in Exhibit 14. We should also perform a Weighted Average Cost of Capital calculation based on the desired equity return of the investors and the potential Debt/Equity ratio. A preliminary estimate assuming a 60%/40% D/E ratio, a required equity return of 20%, a required debt return of 10% and a 41% tax rate would require a minimum discount rate of 11.5%.
4. Given the information provided, $70 seems like a reasonable offer worthy of consideration. The $70 offer is in range based of the Wasserstein analysis and Rales has indicated its willingness to increase the bid if supported by further due diligence. There is no reason to believe that Interco could potentially get a higher bid given that no other suitors exist and also given the recent performance of the stock prior to the news of the initial takeover offer.
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