On September 2, 2010, a little more than two weeks after Company A’s initial bid for Company

B, Company A withdrew from a bidding war with Company C when Company C announced that
it had raised its previous offer by 10% to $33 a share. Company A’s last bid had been $32 per
share, which had trumped COMPANY C’s previous bid the day before of $30 per share. The
final COMPANY C bid valued Company B at $2.1 billion versus Company A’s original offer of
$1.1 billion.

Company B was sought after due to the growing acceptance of its storage product technology
in the emerging “cloud computing” market. Company B’s storage products enable firms to store
and manage their data more efficiently at geographically remote data centers accessible through
the Internet. While Company B has been a consistent money loser, its revenues had been
growing at more than 50% annually since it went public in 2007. The deal valued Company B at
12.5 times 2009 sales in an industry that has rarely spent more than five times sales to acquire
companies. COMPANY C’s motivation for its rich bid seems to have been a bet on a fast-
growing technology that could help energize the firm’s growth. While impressive at $115 billion
in annual revenues and $7.7 billion in net income in 2009, COMPANY C’s revenue and earnings
have slowed due to the 2008–2009 global recession and the maturing markets for its products.

Table below provides selected financial data on Company B and a set of valuation
assumptions. Note that COMPANY C’s marginal tax rate is used rather than Company B’s much
lower effective tax rate, to reflect potential tax savings to COMPANY C from Company B’s
cumulative operating losses. Given COMPANY C’s $10 billion–plus pretax profit, COMPANY
C is expected to utilize Company Bs deferred tax assets fully in the current tax year. The
continued Company B high sales-growth rate reflects the COMPANY C expectation that its
extensive global sales force can expand the sale of Company B products. To support further
development of the Company B products, the valuation assumptions reflect an increase in plant
and equipment spending in excess of depreciation and amortization through 2015; however,
beyond 2015, capital spending is expected to grow at the same rate as depreciation as the
business moves from a growth mode to a maintenance mode. Company B’s operating margin is
expected to show a slow recovery, reflecting the impact of escalating marketing expenses and the
cost of training the COMPANY C sales force in the promotion of the Company B technology.
 Company B Valuation Assumptions and Selected Historical Data

History Projections

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Assumptions

Sales Growth Rate % 0.508 0.450 0.400 0.400 .400 0.350 0.300 0.250 0.200 0.100 0.100

– –
Operating Margin % of Sales –0.020 0.010 0.010 0.020 0.040 0.080 0.100 0.120 0.150 0.150 0.150

Depreciation Expense % of 0.036 0.034 0.060 0.060 0.060 0.060 0.060 0.070 0.070 0.070 0.060
Sales

Marginal Tax Rate % 0.400 0.400 0.400 0.400 0.400 0.400 0.400 0.400 0.400 0.400

Working Capital % of Sale 0.104 0.114 0.100 0.100 0.100 0.100 0.100 0.100 0.100 0.100 0.100

Gross P&E % of Sales 0.087 0.050 0.080 0.080 0.080 0.080 0.080 0.070 0.070 0.060 0.060

WACC (2010–2019) % 0.093

WACC (Terminal Period) % 0.085

Terminal Period Growth Rate % 0.050

Working Capital ($ Million) 112.8 126.4

Total Cash ($ Million) 103.7 111.2

Minimum Cash (5% of 8.4 12.65

Sales)

W Cap Excluding Excess 17.5 27.85

Cash

Selected Financial Data ($ Million)

Sales 168

Depreciation Expense & 6.1

Amortization

Gross Plant & Equipment 14.6

Excess Cash 98.55

Deferred Tax Assets 73.1

PV of Operating Leases 22.0

Number of Shares 61.8

Outstanding
Questions:

1. Estimate Company B’s equity value per share based on the assumptions and
selected Company B data provided in Table 7.2 below?

2. Why is it appropriate to utilize at least a 10-year annual time horizon before

estimating a terminal value in valuing firm’s such as Company B?

3. What portion of the purchase price can be financed by Company B’s

nonoperating assets?

4. Does the deal still make sense to COMPANY C if the terminal period growth
rate is 3 percent rather than 5 percent? Explain your answer.