lonestar graphite Case Study Solution
It is assumed that interest will be paid at the end of each month and the payment frequency will be 72 times in the span of six years.The total interest payment in each year of 2000-2005 amounted to $4.57 million, $ 3.91 million, $3.19 million, $2.39 million, $1.52 million and $0.56 million respectively which has been calculated by adding yearly interest payments of each month. The principal repayment has been calculated by subtracting the monthly payment of each month which is based on the opening balance of loan amount,from the monthly interest expense which is based on the principal amount of the loan. (Exhibit 3)
Benefits of acquiring Lonestar
The benefits that the Hamilton Capital Partners will receive by acquiring Lonestar are mentioned below:
Access to new customers and markets: Since HCP is a medium sized equity firm and Lonestar Graphite has vast geographical outreach as it is operating in three regions, HCP will get the opportunity to increase its profits due to access to new markets and customers.
Global Presence: HCP will get a chance to compete in international markets and reduce its costs by operating in regions where taxes are low and labor is cheap. In addition, the company will be recognized as an international firm.
Financial Benefits: The Company’s financial stability will be ensured as Lonestar is a profitable business, higher returns will be achieved, the tax will be saved as profits will be consolidated which will also ensure shareholder’s confidence in the business as they will enjoy higher dividends.
Strong brand image and Competitive advantage: Lonestar has a strong brand image and is considered to be a market leader in North America. In addition, the company’s ability to convert graphite into silicon carbide has provided it a competitive advantage which makes it an ideal target for acquisition as none of the other competitors have this ability. Therefore, it is certain that HCP’s business performance and liquidity will be improved after the acquisition.
Disadvantages of acquiring Lonestar
Management modifications: Lonestar management comprises of skilled employees and its strong management team is the core strength of the company, however, after the acquisition, the management team might need to be modified as some of the members might be laid off as a result of an acquisition. Therefore, an additional cost will be incurred to train and hire new employees
Cultural differences: Cultural differences might arise as the working methods of both the companies might be different leading to additional cost for training and higher chances of disputes among the employees
Huge Debt: HCP will need to borrow $51.8 million debt to finance the acquisition of Lonestar which will increase its gearing ratio and effect its credit rating, which might create problems in future funding. Similarly, the company’s share price will be effected due to the negative impression created by high gearing and poor credit rating.
Recommendation
It is recommended that HCP should acquire the Lonestar Graphite at the price of $107.13 million which is the average of the NPV estimated in the management case and the downsize case. In order to finance the acquisition, the company will borrow $51.8 million from credit facility senior debt and mezzanine finance. The remaining amount of $55.3 million will be funded through equity and retained earnings as the company can only fund 50% of the total transactional value through equity sources. In addition, the company achieved IRR of 12% and 13% in both the valuation cases, the decision to acquire Lonestar seems viable as the internal rate of return in both cases is higher as compared to the hurdle rate of 11%.
Exhibits
Exhibit 1: APV (Management Scenario)
| Cash Flows | 2000 | 2001 | 2002 | 2003 | 2004 | ||
| EBIT | 10.50 | 11.70 | 14.10 | 17.10 | 20.80 | ||
| EBIT (1-T) | 6.83 | 7.61 | 9.17 | 11.12 | 13.52 | ||
| Depreciation | 3.17 | 3.17 | 3.17 | 3.17 | 3.17 | ||
| Change in working capital | (3.23) | 3.09 | 2.04 | 1.01 | (2.55) | ||
| Capital expenditures | 0.70 | 4.10 | 3.70 | 4.70 | 5.20 | ||
| Free cash flows | 12.53 | 3.59 | 6.60 | 8.58 | 14.04 | ||
| Discount Rate | 11% | ||||||
| Growth Rate | 3% | ||||||
| Terminal Value | 179.98 | ||||||
| Total FCF | 12.53 | 3.59 | 6.60 | 8.58 | 194.02 | ||
| NPV | $139.61 | ||||||
| Tax Shield | 1.60 | 1.37 | 1.12 | 0.84 | 0.53 | ||
| PV of tax Shield | $4.23 | ||||||
| Total Benefits and cost from acquisition | ($139.61) | 14.12 | 4.95 | 7.71 | 9.41 | 194.55 | |
| APV | $143.84 | ||||||
| IRR | 12% |
Exhibit 2: APV (Downsize Scenario)
| Cash Flows | 2000 | 2001 | 2002 | 2003 | 2004 | ||
| EBIT | 9.40 | 6.90 | 6.20 | 9.20 | 9.60 | ||
| EBIT (1-T) | 6.11 | 4.49 | 4.03 | 5.98 | 6.24 | ||
| Depreciation | 3.61 | 3.61 | 3.61 | 3.61 | 3.61 | ||
| Change in working capital | (3.23) | 3.09 | 2.04 | 1.01 | (2.55) | ||
| Capital expenditures | 0.70 | 4.10 | 3.70 | 4.70 | 5.20 | ||
| Free cash flows | 12.25 | 0.91 | 1.90 | 3.88 | 7.20 | ||
| Discount Rate | 11% | ||||||
| Growth Rate | 3% | ||||||
| Terminal Value | 92.3 | ||||||
| Total FCF | 12.25 | 0.91 | 1.90 | 3.88 | 99.50 | ||
| NPV | $74.66 | ||||||
| Tax Shield | 1.60 | 1.37 | 1.12 | 0.84 | 0.53 | ||
| PV of tax Shield | $4.23 | ||||||
| Total Benefits and cost from acquisition | ($74.66) | 13.85 | 2.27 | 3.02 | 4.72 | 100.03 | |
| APV | $78.89 | ||||||
| IRR | 13% |
Exhibit 3: Cash Flow Schedules
| Credit facility | |||||||
| 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | |
| 6.8 | |||||||
| Interest payment | 0.54 | 0.46 | 0.38 | 0.28 | 0.18 | 0.06 | |
| principle repayment’ | 0.91 | 0.99 | 1.08 | 1.17 | 1.27 | 1.27 | |
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