Hong Xing Auto Sales and Service Co. Harvard Case Solution & Analysis

Problem Diagnosis

             The sole owners of Hong Xing Auto Sales and the Service Company are the Li family. The family at the start of the year 2006 was ready to sell the business and wants t determine the value of the business. The owners of the business are also interested to know about the best method to forward the business. They can either sell the business to someone who would manage the business over the future years or they can liquidate the business by selling the assets of the business and paying all the liabilities of the business.

The remaining cash can then be used by Li Nan’s father to finance the advertising agency of Li Nan as a return to her for the sacrifice that she had made for her career development. Therefore, Li family needs to determine the true valuation of the business and also the best method to sell the business. A variety of methods could be employed in this case to value the business which includes the discounted cash flow method, multiples method and the liquidation valuation method. The best medium for selling the business needs to be determined with detailed analysis of the case.

Analysis

            The land that had been recently purchased by the owners has helped a lot in the growth of the business. Furthermore, the growth was also fueled by the long term service contracts with the customers. Along with this, around 70% of the total sales of the business were secured as a result of the annual contracts with the customers. The car service workshop business was also emerging to be a core segment of the consumer market and over the past few years, the business owners with the help of Li Nan had created a reputation in the market of a trusted workshop. This is basically a service oriented industry and the competition was also emerging in the market and over the next few years, it was evident that the competition would become intense in the market.

The industry concentration was also very high due to which he profit margins had decreased. However, the growth of the GDP of the country would result in increased disposable income and increased sales for the future years to come. However, Li Hong Xing is now ill and Li Nan does not want to run the business as the market is changing; therefore, the company needs to determine the best value for the business based upon the future projections and sell the business.

Hong Xing Auto Sales and Service Co. Case Solution

Assumptions

             First of all in order to value the business certain basic assumptions have been established for the next five years for the business. In order to value the business on the basis of the discounted cash flow method, the weighted average cost of capital needs to be computed. The market rate of return of 15% has been assumed looking at the changing dynamics of the market. As the company is not listed, therefore, the beta has been estimated on the basis of the past performance of the company and looking at the leverage of the business also. Based upon the assumption as provided in the excel spreadsheet, the weighted average cost of capital for the business has been calculated to be around 9.12%.

            The interest rate and interest expense have been calculated based upon the current 1000000 Yuan loan taken and the ax rate is 33%. The dividends have been assumed to be on the same level of 200,000 Yuan. The cost of goods sold has been calculated to be as the average percentage of the sales over the period of the past 5 years. In the similar manner, all the average growth rates for the operating expenses have been calculated based upon the expenses provided in exhibit 3.

Pro-forma Financial Statements

            First of all, the proforma income statement for the next five years from 2006 to 2010 has been created. The sales have been assumed to grow in year 1 and year 2 on the basis of the past 5 years average growth rate, in year 3 and 4 at 20% and in the last year at 15%. This is because more competitors would be entering in the market in the next five years. The service business tax and the cost of goods sold have been calculated based upon the past 5 years’ average growth rate. Regarding the operating expenses, all those expenses that were either increasing or running up or down over the past few years have been projected for the next five years based upon the average historical growth rate............................

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