QUESTION 1
Did the purchase of the Lexington Club real estate increase the value of HDC? Use pre-tax cash
flows and assume that the appropriate discount rate for real estate cash flows was 10%.
health development corporation case solution
The net present value for both the scenarios has been calculated that is if the Lexington Real Estate Property is owned by the management of the company or if it is leased. The pretax cash flows for the Lexington Real Estate Property has been used for the period of 20 years which has been assumed as the estimated life of the facility. The discount rate at which the cash flows of the company are discounted is taken as 10%, provided by the question. Further, the revenues for the foreseeable future for the Lexington Club have been assumed to grow at a consistent rate of 5%.
The incremental cash flows resulting from the purchase have been taken. If we examine the operating income of this property, then it could be seen that for the owned and the leased scenario, the lease cost if the only factor which is different and all the other factors are same. The repayment of the interest would not be considered as the cost of operations but it is basically he cost of debt for the company. It has been already accounted for in the 504000 perpetuity outflow. So this amount has also not been included in the pretax cash flows. Based on the net present value that has been calculated for both the options, it could be seen that the present value of owning the Lexington Real Estate Property is much higher than leasing it.
QUESTION 2
Why does the Lexington Club real estate purchase reduce the offer prices? Does it make sense?
The valuation of HDC performed by TSI is done on the basis of multiples that is (EBITDA*5) - Debt. The EBITDA for the year 2000 has been projected at 5 times and at this multiple the value of HDC has been derived for lease and the owner option, as shown in exhibit 3 of the case. However, we can see that there is a $ 1.87 million difference in the valuations of both the companies. The EBITDA is much larger for owning the Lexington Real Estate Property and it is larger by $925000 at a multiple of 5 which totals $4625000.
Apart from this, the other difference in the leasing and the owning valuation is the cost of buying Lexington of $6500000 into multiple of 5 times less debt. Therefore, it could be seen that this multiple of 5 has a very huge difference over the valuation of both the scenarios. This fixed multiple might not reflect the risk that has been involved. Hence, using different multiples might give some sense to both the valuations. However, based on the current multiple of 5 times it does make sense to reduce the offer price of the Lexington Real Estate Property is purchased.
QUESTION 3
Will the sale-leaseback of the Lexington Club real estate increase the offer price? How would
you structure the deal?
The ownership of the Lexington Club could be restructured by the company in order to resolve the current real estate problem as stated by the valuations performed by TSI. This deal could be structured in the following way:
HEALTH DEVELOPMENT CORPORATION CASE SOLUTION
A new holding company with any name should be created and the ownership of the Lexington Club would be with that company. That company could then lease the club to HDC. The enw holding company would be completely owned by the stockholders if the company and they would then sell out HDC to TSI. The sale will take place at a value that has been decided by TSI as shown in exhibit 3. Then HDC could lease the property back for a period of minimum 20 years. The lease payment each year would be around $525000. In order for the holding company to purchase this club, a loan could be raised which will have to be paid back in equal payments in a time period of 20 years.
Since, 110% of the bank loan should be the annual payments as stated by the bank, then HDC original owners could inject the difference that would arise between the loan that would be raised and the purchase price of Lexington Club. This way the company could structure this deal and get a much higher offer price by TSI. ..............................
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