American Greetings Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Buyback of Own Shares

However, the AG was concerned about the decline in its share price and believed that its shares are undervalued as evaluated through the earnings multiple valuations of the competitors. Meanwhile, the management of AG was preparing for a share buyback scheme in the view that this will overcome the declined share price issue and will increase the AG’s overall valuation. However, the AG’s plan is to invest $75 million for the buyback program, meanwhile, the management is equally concerned about the short term or long term prospect of the decline in its share price. Because the management believed that if the decline in share price is a short term effect, then the buyback program will improve the share price and on the other hand, if the decline in share price is with the long term perspective then the buyback program would not be able to achieve the desired results of share price increase. Therefore, the management of AG is in a dilemma, where they have to decide that whether the $75 million should be invested in buyback program or they should be used to improve the operations and revenues of AG in order to have a long term effect on share price.

Net Present Value(NPV) Model

The net present value model uses the estimated future cash flows of a business in order calculation the fair value of the business on a going concern basis.Further, the future expected cash flows are discounted using appropriate risk adjusted discount rate that represents the risk involved in the investment project. Additionally, since a going concern business is expected to continue for an infinite period, therefore, terminal value is calculated in order to incorporate a value that represents the value of future cash flows after a certain year of the period.

Additionally, the cost of equity for AG has been calculated using the capital asset pricing model, for which the risk free rate has been taken as the 10 year Treasury bond rate, meanwhile, the equity risk premium, has been taken from the last five year historical returns. However, the incorporating the cost of equity and after tax cost of debt have led to the calculation of 9.08% of the combined cost of capital for AG, which have been used in order to discount the future cash flows of AG.

Bullish Scenario

The bullish scenario considers the optimistic view of business operations and calculated the future estimated cash flows of a business under the optimistic conditions. Therefore, under the bullish scenario, the future cash flows of the AG are expected to grow as per the growth rates seen in exhibit 8 of the case. Further, the operating margins have been estimated to increase as per actual growth rate with the slightly reduced rate, meanwhile, investment in net working capital has also been estimated to increase in line with the increase in revenues and investment in fixed will not change in subsequent years. Additionally, the terminal values after year 2015, has been calculated with the optimistic assumption that they will increase at 3% till infinity, and the net cash flows have been discounted at the weighted average cost of capital of 9.08%. Hence, the net present value of AG operations has been calculated at $1414 million and the equity value after deduction of debts has been arrived at $1,179 million.

Bearish Scenario

On the other hand bearish scenario considers the pessimistic view and calculates the future cash flows of AG with less favorable conditions. However, under the bearish scenario the future revenues are expected to be constant, meanwhile, the operating margins have also been expected to decline. Further, the investment in working capital and fixed has been assumed to be the same as in bullish scenario, additionally, the terminal values after the year 2015 has been estimated to grow at a nil rate. Therefore, the net present value of AG under bearish scenario has been estimated to be $848 million and an equity value of $613 million.

Buyback of Equity Shares

However, the decision regarding the buyback of AG’s share has to be evaluated under different scenarios, which included the multiples, bearish and bullish. However, the current share price of AG is $12.51 per share, which implies an enterprise value of AG at 3.5 times of its EBITDA multiple, further the future value of AG is based on its ability to generate revenues and high profit margins which will increase the investors’ confidence in AG’s long term growth.................................

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