GreenEarth Corporation Case Study
Introduction and Background
a) Evaluating the components of WACC for the valuation:
|
Particular |
Value |
|
Corporate Bond |
42.00% |
|
Yield |
9.50% |
|
Equity |
58.00% |
|
Risk free rate |
8.49% |
|
Beta |
1.35 |
|
Market Premium |
7.00% |
|
Cost of equity |
17.94% |
|
Tax |
34.00% |
|
WACC |
13.04% |
There are specific components of WACC, which is used for detecting the level of cost of capital required for GreenEarth. In addition, from the evaluation it can be detected that WACC is mainly at the levels of 13.04%, which is calculated from cot of equity and cost of capital. Moreover, the major components of WACC is Debt, Equity and tax rate, which helps in determining the cost of capital of the firm. The corporate bond composition is 42%, while equity is at 58%. The cost of debt is calculated at 9.50%, while the cost of equity is 17.94% with a tax rate of 34%.
|
Charlotte Mill |
1994 |
1995 |
1996 |
1997 |
1998 |
|
Capex |
18 |
18 |
18 |
18 |
18 |
|
Change in working capital |
19.2 |
33 |
19.2 |
9.9 |
8.1 |
|
Free Cash flow |
113.1 |
145.7 |
223.2 |
219.3 |
223.1 |
|
WACC |
15% |
||||
|
Growth |
5% |
||||
|
NPV |
$591.58 |
||||
|
Terminal Value |
$2,231.00 |
||||
|
PV of the Terminal Value |
$ 1,109 |
||||
|
Enterprise Value |
$1,701 |
||||
|
Debt |
$0 |
||||
|
Equity Value |
$1,805 |
The above table directly indicates the level of Equity level, which is mainly calculated with the help of terminal value. The calculation directly helps in detecting the total equity value of $1,805 is mainly calculated from the free cash flow, which also include the 104.5 million of net working capital (Koziol, 2014). The calculation would eventually help in detecting the level of minimum purchase value of Charlotte Mill. Thus, GreenEarth needs around $1,805 million for purchasing Charlotte Mill.
The increment in depreciation value of the Charlotte mill would eventually reduce the overall taxes, which will increase the level of Free cash flow in the long. This would eventually raise the value of NPV and the Equity value of the company. The rising values of free cash flow would eventually help in detecting the level of cash that is being present within the operations of the company. Thus, the equity value of Charlotte Mill would eventually increase with the increment in deprecation value (Harris, 2017).
|
Particular |
Value |
Value |
|
Daily value |
400,000 |
670,000 |
|
daily tons |
3,688 |
3,688 |
|
60% of the purchase value |
1,475 |
2,471 |
|
Purchase value |
2,459 |
4,118 |
The transaction cost that will be suggested by Stone Corporation is mainly calculated in the above table, where the purchase values will be ranging from $2,459 million to $4,118 million. This measure is mainly conducted with unique ability of the company to ensure the relevant purchase price of Charlotte Mill. The calculation conducted by Stone Corporation will eventually raise the level of purchase price of Charlotte mill from the calculated equity value of $1,805 million.
a) Indicating the vale that will be added from the expansion project to add the value of paper mill:
|
Particulars |
1994 |
1995 |
1996 |
1997 |
1998 |
1999 |
|
Free Cash flow |
113.1 |
145.7 |
223.2 |
219.3 |
223.1 |
234.255 |
|
Capex |
-600 |
|||||
|
FCF |
113.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
324.255 |
|
113.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
279.255 |
|
|
113.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
369.255 |
|
|
Estimated cash flow |
113.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
324.255 |
|
WACC |
15% |
|||||
|
Growth |
5% |
|||||
|
NPV |
$433.46 |
|||||
|
Terminal Value |
$3,242.55 |
|||||
|
PV of the Terminal Value |
$ 1,402 |
|||||
|
Enterprise Value |
$1,835 |
|||||
|
Debt |
$0 |
|||||
|
Equity Value |
$1,940 |
|||||
|
Old Equity Value |
$1,805 |
|||||
|
Value Added |
$135 |
From the overall calculation it can be detected that the value of equity will mainly increase by $135 after adopting the $600 million expenses in 1998. This expense will ensure the continuity of the operations, where the probability of 50% increment in free cash flow and decline in free cash flow is estimated. This expense will eventually raise the level of equity to $1,940 million from $1,805 million.
b) Indicating the value that will be added by the expansion project to the paper mill with an additional cost of $100 million:
|
Particulars |
1994 |
1995 |
1996 |
1997 |
1998 |
1999 |
|
Free Cash flow |
113.1 |
145.7 |
223.2 |
219.3 |
223.1 |
234.255 |
|
Capex |
-100 |
-600 |
||||
|
FCF |
13.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
324.255 |
|
13.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
279.255 |
|
|
13.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
369.255 |
|
|
Estimated cash flow |
13.1 |
145.7 |
223.2 |
219.3 |
-376.9 |
324.255 |
|
WACC |
15% |
|||||
|
Growth |
5% |
|||||
|
NPV |
$346.50 |
|||||
|
Terminal Value |
$3,242.55 |
|||||
|
PV of the Terminal Value |
$ 1,402 |
|||||
|
Enterprise Value |
$1,748 |
|||||
|
Debt |
$0 |
|||||
|
Equity Value |
$1,853 |
|||||
|
Old Equity Value |
$1,805 |
|||||
|
Value Added |
$48 |
The calculation indicates that the expenses conducted in 1994 for around $100 million will increase the equity value of $48 million. This increment in value is estimated with probability condition, which will generate high level of income from operations. The equity value will increase to $1,853 from 1,805 million with the extra income and capital expense conducted in 1994 and 1998.
Yes, it does make strategic sense to purchase the mill from Wickes, as it will increase profitability and income of the organisation in the long run. GreenEarth needs to provide the full valuation of the mill, as other competitors would also be bidding for the mill. No, I do not expect that the bid value of GreenEarth will be the highest bidder for the mill. Diversification is an adequate measure, which allows in minimising the risk attributes of the organisation. However, diversification will raise the level of expense for GreenEarth and investing in offset coated paper would increase value of the firm in the long run. Hence, the investment would eventually help in generating high level of income for GreenEarth after acquiring the mill (Frank & Shen, 2016).
a) Explaining the argument behind the recommendation in detail:
|
Particular |
Value |
|
STD (Short-term debt) |
$ 10 |
|
LTD, current portion |
$ 95 |
|
LTD (Long-term debt) |
$ 1,523 |
|
Credit line |
$ 600 |
|
Total Debt |
$ 2,228 |
|
Common stock issue |
$ 1,000 |
|
Common Equity |
$ 2,242 |
|
Total Common Equity |
$ 3,242 |
|
Total Capital |
$ 5,470 |
|
Particular |
Value |
|
Corporate Bond |
41% |
|
Yield |
9.50% |
|
Equity |
59% |
|
Risk free rate |
8.49% |
|
Beta |
1.35 |
|
Market Premium |
7.00% |
|
Cost of equity |
17.94% |
|
Tax |
34.00% |
|
WACC |
13.19% |
The combination of credit line and common stock issue would be an effective measure for securing the capital that will be required for acquiring the mill. The capital from credit will be at the levels of $600 million, while the common stock issue will be conducted for $1 billion. The capital structure indicates the debt weighted of the firm to 41%, while the equity weightage is 59%. Therefore, the capital structure proposed for the organisation is following the financial policies and the debt is within the confinements of 45%. However, the inclusion of debt and equity capital has not altered the WACC of the organisation significantly, which mainly depicts the financial viability of the acquisition of the mill.
|
Particular |
Value |
|
STD (Short-term debt) |
$ 10 |
|
LTD, current portion |
$ 95 |
|
LTD (Long-term debt) |
$ 1,523 |
|
Additional debt |
$ 500 |
|
Total Debt |
$ 2,128 |
|
Common stock issue |
$ 1,000 |
|
Common Equity |
$ 2,242 |
|
Total Common Equity |
$ 3,242 |
|
Debentures |
$ 600 |
|
Total Capital |
$ 5,970 |
|
Particular |
Value |
|
Corporate Bond |
36% |
|
Yield |
9.50% |
|
Equity |
54% |
|
Debentures |
10% |
|
D-Yield |
10.25% |
|
Risk free rate |
8.49% |
|
Beta |
1.35 |
|
Market Premium |
7.00% |
|
Cost of equity |
17.94% |
|
Tax |
34.00% |
|
WACC |
13.01% |
The inclusion of debt will not change the decision for acquiring the mill, as the value is derived from the calculation, which is at $1,305 million. Hence, investment in the mill would eventually help in generating high level of income from operations. Yes, the additional debt will change the overall price that we offer, as the equity valuation of the company will decline. No, the decision for acquiring the asset will not change, as it will increase the capability of the organisation to generate high revenues in the long run. Yes, the addition debt will change the financing decision, as debentures will be used for supporting the finances, as it will reduce the debt composition of the organisation (Curry, Xia & Chen, 2018).
References:
Curry, J., Xia, H., & Chen, K. C. (2018). To Sell or Not to Sell? a Case on Business Valuation. Journal of the International Academy for Case Studies, 24(2), 1.
Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), 300-315.
Harris, R. S. (2017). A Comparison of the Weighted-Average Cost of Capital and Equity-Residual Approaches to Valuation. Darden Business Publishing Cases, 1-5.
Koziol, C. (2014). A simple correction of the WACC discount rate for default risk and bankruptcy costs. Review of Quantitative Finance and Accounting, 42(4), 653-666.