Question 3b
Doric Co has two manufacturing divisions: parts and fridges. Although the parts division is profitable, the fridges division is not, and as a result its share price has declined to $0.50 per share from a high of $2.83 per share around three years ago. Assume it is now 1 January 2013 .
The board of directors are considering two proposals:
(i) To cease trading and close down the company entirely, or;
(ii) To close the fridges division and continue the parts division through a leveraged management buyout.. The new company will continue with manufacturing parts only, but will make an additional investment of $50 million in order to grow the parts division after-tax cash flows by 3.5% in perpetuity.
The proceeds from the sale of the fridges division will be used to pay the outstanding liabilities. The finance raised from the management buy-out will pay for any remaining liabilities, the funds required for the additional investment, and to purchase the current equity shares at a premium of 20%. The fridges division is twice the size of the parts division in terms of its assets attributable to it.
Extracts from the most recent financial statements:
Financial Position as at 31 December 2012
| $m | |
| Non-Current Assets | 110 |
| Current Assets | 220 |
| Share capital ($0.40 per share par value) | 40 |
| Reserves | 10 |
| Liabilities (Non-current and current) | 280 |
Income Statement for the year ended 31 December 2012
| $m | |
| Sales revenue: Parts division | 170 |
| Fridges division | 340 |
| Costs prior to depreciation, interest payments and tax: Parts division | (120) |
| Fridges division | (370) |
| Depreciation, tax and interest | (34) |
| ------ | |
| Loss | (14) |
| ------ |
The following additional information has been provided
Redundancy and other costs will be approximately $54 million if the whole company is closed, and pro rata for individual divisions that are closed. These costs have priority for payment before any other liabilities in case of closure. The taxation effects relating to this may be ignored.
Corporation tax on profits is 20% and it can be assumed that tax is payable in the year incurred. Annual depreciation on non-current assets is 10% and this is the amount of investment needed to maintain the current level of activity. The new company’s cost of capital is expected to be 11%.
Required:
Estimate the return the liability holders and the shareholders would receive in the event that Doric Co is closed and all its assets sold. (3 marks)