In the summer of 2010, Smidgeon industries was evaluating whether or not to purchase one of its suppliers, the supplier, Carswell Manufacturing, provides Smidgeon with the raw steel Smidgeon uses to fabricate utility trailers. One of the first things that Smidgeon's management did was to forecast the cash flows of Carswell for the next five years:
Year cash flows
1 1,200,000
2 1,260,000
3 1,323,000
4 1,389,150
5 1,458,608
Next, Smidgeon's management team looked at a group of similar firms and estimated Carswell's cost of capital to be 15%. Finally, they estimated that Carswell would be worth approximately six times its year 5 cash flow in five years.
a. What is your estimate of the enterprise value of Carswell?
b. What is the value of the equity of Carswell if the acquisition goes through and Smidgeon borrows $2.4 million and finances the remainder using equity?