Sterling Household Products Company

Exhibit 1 Income Statement for Sterling Household Products Company

($ in millions except per share amounts) 2010 2011 2012

Net sales $3,140 $3,138 $3,281

Cost of goods sold $1,742 $1,751 $1,860
Gross profit $1,398 $1,387 $1,421

General, selling & administrative expenses $726 $740 $769

Research & development expenses $67 $72 $78
Income before interest and income taxes $605 $575 $574

Interest expenses $83 $70 $76

Income before income taxes $522 $505 $498

Income taxes expenses $178 $171 $175

Net income $344 $334 $323

Weighted number of shares outstanding (in thousands) 84,160 81,520 79,508

Earnings per share $4.09 $4.10 $4.06
Dividends per share $2.44 $2.44 $2.44

Stock price at end of year $58.79 $63.78 $65.46

Price/Earnings ratio 14.4 15.6 16.1
Equity beta coefficient 0.40
Sterling Household Products Company

Exhibit 2 Balance Sheet for Sterling Household Products Company

($ in millions except per share amounts) 2010 2011 2012

Assets
Current assets
Cash and cash equivalents $202 $305 $346
Accounts receivable, net $324 $315 $346
Inventories, net $199 $229 $231
Other current assets $318 $91 $96
Total current assets $1,043 $940 $1,019

Property, plant & equipment, net $580 $653 $669

Goodwill & trademarks $1,019 $903 $912
Other assets $86 $91 $86
Total assets $2,728 $2,587 $2,686

Liabilities & Shareholder's Equity

Current liabilities
Accounts payable $245 $254 $243
Short-term bank notes payable $222 $275 $181
Accrued liabilities $339 $290 $299
Total current liabilities $806 $819 $723

Long-term debt $1,274 $1,106 $1,257

Other long-term liabilities $418 $455 $497
Total liabilities $2,498 $2,380 $2,477

Shareholders' equity
Contributed capital $466 $474 $478
Retained earnings $2,552 $2,687 $2,816
Treasury stock -$2,788 -$2,954 -$3,085
Stockholders' equity $230 $207 $209

Total liabilities & shareholders' equity $2,728 $2,587 $2,686

Sterling Household Products Company

Exhibit 3 Income Statement for Montagne Medical Instruments Company

($ in millions except per share amounts) 2010 2011 2012

Net sales $1,396 $1,622 $1,756

Cost of goods sold $408 $481 $581
Gross profit $988 $1,141 $1,175

General, selling & administrative expenses $534 $630 $671

Research & development expenses $127 $144 $154
Income before interest and income taxes $327 $367 $350

Interest expenses $0 $0 $0
Income before income taxes $327 $367 $350

Income tax expenses $91 $101 $93

Net income $236 $266 $257

Weighted number of shares outstanding (in thousands) 113,607 117,538 118,618

Earnings per share $2.08 $2.26 $2.17

Stock price at end of year $31.37 $36.48 $35.24

Price/Earnings ratio 15.1 16.1 16.3
Equity beta coefficient 0.97
Sterling Household Products Company

Exhibit 4 Balance Sheet for Montagne Medical Instruments Company

($ in millions except per share amounts) 2010 2011 2012

Assets
Current assets
Cash and cash equivalents $109 $306 $541
Accounts receivable, net $202 $247 $256
Inventories, net $126 $180 $184
Other current assets $73 $86 $93
Total current assets $510 $819 $1,074

Property, plant & equipment, net $101 $187 $216

Intangible assets, net $41 $44 $53
Other assets $66 $71 $97
Total assets $718 $1,121 $1,440

Liabilities & Shareholders' Equity

Current liabilities
Accounts payable $67 $89 $113
Accrued liabilities $112 $137 $148
Total current liabilities $179 $226 $261

Long-term debt $1 $1 $0
Other long-term liabilities $27 $40 $46
Total liabilities $207 $267 $307

Shareholders' Equity
Contributed capital $347 $424 $446
Retained earnings $249 $515 $772
Treasury stock -$85 -$85 -$85
Shareholders' equity $511 $854 $1,133

Total liabilities & shareholders' equity $718 $1,121 $1,440

Sterling Household Products Company

Exhibit 5 Financial Information for Montagne Medical Instruments Company's

germicidal, sanitation and antiseptic products unit

Income Statement
($ in thousands) 2010 2011 2012

Net sales $128,462 $135,496 $142,528 Growth 5.476% 5.190%

Manufacturing expenses $71,399 $75,512 $79,231

Selling & administrative expenses $27,285 $28,712 $30,301
Research & development expenses $3,314 $3,618 $3,606
Depreciation expenses $2,216 $2,329 $2,438
Total costs $104,215 $110,170 $115,577

Operating income $24,247 $25,326 $26,951

Balance sheet
($ in thousands) 2010 2011 2012

Operating assets:
Accounts receivable $16,533 $17,217 $17,675
Inventory $21,059 $22,772 $23,802 $27,019
Property, plant & equipment, at cost $43,840 $46,172 $48,454
- Accumulated depreciation $16,366 $18,695 $21,133
Property, plant & equipment, net $27,474 $27,477 $27,321
Total operating assets $65,066 $67,466 $68,798

Operating liabilities:
Accounts payable $10,573 $11,143 $11,689

Net operating assets $54,493 $56,323 $57,109

Percent of sales ratios: 2010 2011 2012

Manufacturing expenses 55.6% 55.7% 55.6%
Selling & administrative expenses 21.2% 21.2% 21.3%
Research & development expenses 2.6% 2.7% 2.5%
Accounts receivable 12.9% 12.7% 12.4%
Inventory 16.4% 16.8% 16.7%
Property, plant & equipment, net 21.4% 20.3% 19.2%
Accounts payable 8.2% 8.2% 8.2%
Sterling Household Products Company

Exhibit 6 Pro Forma Financial Information for Montagne Medical Instruments Company's germicidal, sanitation
and antiseptic products unit

Income Statement
($ in thousands) 2013 2014 2015 2016 2017

Net sales $149,369 $152,954 $156,625 $160,384 $164,233

Manufacturing expenses $83,049 $84,890 $86,927 $89,013 $91,149

Selling & administrative expenses $31,666 $32,120 $32,891 $33,681 $34,489
Research & development expenses $3,734 $3,824 $3,916 $4,010 $4,106
Depreciation expenses $2,525 $2,600 $2,675 $2,750 $2,825
Total costs $120,975 $123,434 $126,409 $129,453 $132,569

Operating income $28,394 $29,520 $30,216 $30,931 $31,664

Balance sheet
($ in thousands) 2013 2014 2015 2016 2017

Operating assets:
Accounts receivable $18,522 $18,966 $19,422 $19,888 $20,365
Inventory $24,945 $25,543 $26,156 $26,784 $27,427
Property, plant & equipment, at cost $50,192 $51,692 $53,192 $54,692 $56,192
- Accumulated depreciation $23,658 $26,258 $28,933 $31,683 $34,508
Property, plant & equipment, net $26,534 $25,434 $24,259 $23,009 $21,684
Total operating assets $70,000 $69,944 $69,837 $69,681 $69,476

Operating liabilities:
Accounts payable $12,248 $12,542 $12,843 $13,151 $13,467

Net operating assets $57,752 $57,401 $56,994 $56,529 $56,009

Percent of sales ratios: 2013 2014 2015 2016 2017

Manufacturing expenses 55.6% 55.5% 55.5% 55.5% 55.5%
Selling & administrative expenses 21.2% 21.0% 21.0% 21.0% 21.0%
Research & development expenses 2.5% 2.5% 2.5% 2.5% 2.5%
Accounts receivable 12.4% 12.4% 12.4% 12.4% 12.4%
Inventory 16.7% 16.7% 16.7% 16.7% 16.7%
Property, plant & equipment, net 17.8% 16.6% 15.5% 14.3% 13.2%
Accounts payable 8.2% 8.2% 8.2% 8.2% 8.2%
Sterling Household Products Company

Exhibit 7 Financial information for selected companies in S.I.C. 3841 (surgical and medical instruments & apparatus) with
significant shares of the germicidal, sanitation, and antiseptic products market
Teleological Labyrinth Stratus
2010 2011 2012 2010 2011 2012 2010 2011 2012
Sales revenue ($ in millions) $683 $682 $728 $455 $488 $520 $224 $306 $338
Net income ($ in millions) $144 $96 $154 $34 $44 $19 $23 $42 $58
Earnings per share $7.63 $5.04 $7.98 $1.74 $2.17 $0.95 $0.50 $0.92 $1.21
Dividends per share $1.36 $1.36 $1.36 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00

Year-end price/earnings ratio 6.97 10.77 7.56 19.28 18.78 46.52 53.12 33.70 24.93
Year-end common stock price $53.15 $54.30 $60.36 $33.55 $40.75 $44.19 $26.56 $31.00 $30.16
Market value of equity ($ in millions) $1,003.1 $1,034.3 $1,164.8 $655.6 $826.3 $883.8 $1,221.8 $1,415.2 $1,445.7

Balance sheet capitalization $1,320 $1,271 $1,398 $503 $530 $683 $526 $608 $467
% debt 43% 33% 32% 41% 37% 52% 20% 18% 0%
% common stock 57% 67% 68% 59% 63% 48% 80% 82% 100%

Equity beta coefficient --- --- 1.02 --- --- 1.04 --- --- 0.86
Interest coverage 2.8 2.9 3.3 4.2 5.4 2.0 4.1 8.2 24.5

Chiron Vortex Pathogen

2010 2011 2012 2010 2011 2012 2010 2011 2012
Sales revenue ($ in millions) $200 $192 $223 $144 $186 $218 $152 $179 $215
Net income ($ in millions) $20 $8 $22 -$18 $6 $24 $11 $11 $17
Earnings per share $2.18 $0.86 $2.33 -$0.60 $0.20 $0.73 $0.79 $0.80 $1.17
Dividends per share $0.44 $0.56 $0.66 $0.00 $0.00 $0.00 $0.07 $0.08 $0.09

Year-end price/earnings ratio 13.83 36.70 13.23 n/a 126.70 34.48 22.67 21.18 21.19
Year-end common stock price $30.14 $31.56 $30.83 $16.24 $25.34 $25.17 $17.91 $16.94 $24.79
Market value of equity ($ in millions) $276.5 $293.6 $291.1 $487.2 $760.2 $827.5 $249.4 $232.9 $360.2

Balance sheet capitalization $153 $158 $164 $136 $232 $275 $122 $143 $201
% debt 22% 21% 20% 0% 25% 22% 5% 9% 25%
% common stock 78% 79% 80% 100% 75% 78% 95% 91% 75%

Equity beta coefficient --- --- 0.85 --- --- 0.53 --- --- 0.90
Interest coverage 15.5 7.1 18.4 n/a 4.5 3.6 27.9 32.6 14.0
Answer to question 1

Ans 1)

Business risk is the possibility a company will have lower than anticipated profits
or experience a loss rather than taking a profit. Business risk is influenced by
numerous factors, including sales volume, per-unit price, input costs, competition,
the overall economic climate and government regulations.

When valuing a target for acquisition the cost of capital and the discounting rates which are used are for the tar
hence here when we have to evaluate the target we should be using the targets cost of equity and cost of capita
or undervalued or overvalued

Sterling Currently the capital structure for sterling After Acquisition

Debt 20% 30%
Equity 80% 70%
Kd 4.50% 5.10%

Montagne
All 6 firms average equity beta 0.87
2 firms more similar 0.88

We get very similar betas though it would be more appropriate to use the beta for similar firms because montangne has 100%

Beta equity 0.88

Cost of Equity 7.48% Re = Rf + Beta(MRP)

This is also the cost of equity of the unlevered firm

But as we see from Exhibit 4 the balance sheet of Montagne the amount of debt is almost 0

Assuming the debt to be 0 in the target since it is close to 0

If we see closely the capital structure of the target

Equity 100%
Debt 0%

Wacc 7.48% This can be used for valuing the target to see if the value is actually 265 million which means to k

These Cost of Equity and Wacc are for valuating the firm to know if it is actually worth

But if we were to check the NPV for this project we would use the cost of capital of the sterling
i.e for investment cash flows we should be using wacc for sterling and the capital structure that would be right for assessing th
after aquiring the firm with the new capital structure which is 70% equity and 30% debt

Equity beta for sterling = .40 Beta sterli 0.4 asset beta =' 0.32
ke = 5.100% Beta Monta 0.87 is also equal to asset beta for company since debt
if we take the average beta 0.447 considering 90% equity of ste
new ke of the firm with 30 % debt now equity beta for combined firm 0.638571
6.293%

WACC for the combined firm

capital structure
debt 30% kd 5.10%
Equity 70% ke 6.29%
tax 35%

expected return on assets 5.33500%

WACC = 5.399600%
 In any merger we consider 10% of the customers on an average could be lost in an acquisition
If we consider the business risk associated in this deal we firstly spend 265 million further more there could
be lost of customers because of the brand name that will change
Secondly we are taking debt for this acquisition which increases our financial leverage so we may actually be hurt even harded

A sensitivity analysis could help us estimate the amount of business risk associated with the acquisition

which are used are for the target not the aquirer
ost of equity and cost of capital to see if it is rightly valued

The price quoted is 265 million WC CA-CL

MRP 5%
Rf 3.10%

because montangne has 100% germicidal line of products

y 265 million which means to know if the right price was paid

would be right for assessing this would be

before combining
t beta for company since debt was 0
considering 90% equity of sterling and 10% of target
considering beta debt to be 0
 e there could

may actually be hurt even harded if the expected cash flows are not realized
Ans 2) Lets look at the cash flows from 2013 to 2022
We already have a prepared forecasts for the next 5 years ie 2013 to 2017

To estimate the cash flows for next 5 years assuming a growth of 5% in the sales a
of these 5 years to predict for next 5 years
Find Below the projected values for operated income for the next 10 years

Income Statement
($ in thousands) 2013 2014 2015 2016

Net sales $149,369 $152,954 $156,625 $160,384

Manufacturing expenses $83,049 $84,890 $86,927 $89,013

Selling & administrative expenses $31,666 $32,120 $32,891 $33,681
Research & development expenses $3,734 $3,824 $3,916 $4,010
Depreciation expenses $2,525 $2,600 $2,675 $2,750
Total costs $120,975 $123,434 $126,409 $129,453

Operating income $28,394 $29,520 $30,216 $30,931

Balance sheet
($ in thousands) 2013 2014 2015 2016

Operating assets:
Accounts receivable $18,522 $18,966 $19,422 $19,888
Inventory $24,945 $25,543 $26,156 $26,784
Property, plant & equipment, at cost $50,192 $51,692 $53,192 $54,692
- Accumulated depreciation $23,658 $26,258 $28,933 $31,683
Property, plant & equipment, net $26,534 $25,434 $24,259 $23,009
Total operating assets $70,000 $69,944 $69,837 $69,681
Capex for the year $1,738 $1,500 $1,500 $1,500
Operating liabilities:
Accounts payable $12,248 $12,542 $12,843 $13,151

Net operating assets $57,752 $57,401 $56,994 $56,529

NWC = CA - CL $31,218 $31,967 $32,735 $33,520
Change $4,199 $749 $767 $786

Percent of sales ratios: 2013 2014 2015 2016

 Manufacturing expenses 55.6% 55.5% 55.5% 55.5%
Selling & administrative expenses 21.2% 21.0% 21.0% 21.0%
Research & development expenses 2.5% 2.5% 2.5% 2.5%
Accounts receivable 12.4% 12.4% 12.4% 12.4%
Inventory 16.7% 16.7% 16.7% 16.7%
Property, plant & equipment, net 17.8% 16.6% 15.5% 14.3%
Accounts payable 8.2% 8.2% 8.2% 8.2%

1 2 3 4
Now free cash flows = Operating income + Depreciation - WC - Capex
2013 2014 2015 2016
FCF $15,044 $19,539 $20,048 $20,569

Taxes as 35%
Terminal value 9 times the cash flow of 2022
$205,361.32
PV of TV $121,374.94

PV $14,273.49 $19,539.01 $20,048.36 $20,569.30

NPV of this investment -Investment +_ PV of all future cash flows'
Initial investment lets assume the company was bought for 265 million

Combined Base and Expansion project

Expansion project
currently operating at full capactity
Initial investment for expansion = 60 million 60000000
Capex each year = 600000
Depreciation straight line method 20 years life
increased depreciation each year will be 3000000

2013 2014 2015 2016

Net sales $149,369 $183,545.05 $203,612.64 $224,537.76

Manufacturing expenses $82,929.86 $101,904.21 $113,045.74 $124,663.36

Selling & administrative expenses $31,427.31 $38,617.88 $42,840.10 $47,242.74
Research & development expenses $3,734 $3,824 $3,916 $4,010
Depreciation expenses $5,525 $5,600 $5,675 $5,750
Total costs $40,686.54 $48,041.73 $52,430.73 $57,002.35

Operating income $42,243.32 $53,862.48 $60,615.01 $67,661.02

Balance sheet
($ in thousands)

Operating assets:
Accounts receivable $18,521.80 $22,759.59 $25,247.97 $27,842.68
Inventory $24,944.68 $30,652.02 $34,003.31 $37,497.81
Property, plant & equipment, at cost $50,192 $111,692 $113,192 $114,692
- Accumulated depreciation $23,658 29258 28933 31683
Property, plant & equipment, net $26,534.00 82434 84259 83009
Total operating assets $70,000.48 $135,845.61 $143,510.28 $148,349.49
Capex for the year $1,738 $61,500 $1,500 $1,500
Operating liabilities:
Accounts payable $12,248.29 $15,050.69 $16,696.24 $18,412.10

Net operating assets $57,752.19 $120,794.92 $126,814.04 $129,937.39

NWC = CA - CL $31,218.19 $38,360.92 $42,555.04 $46,928.39
Increase in WC $4,198.78 $7,142.72 $4,194.13 $4,373.35

1 2 3 4
FCFF $5,913.38 -$33,557.11 $33,780.63 $38,181.31
PV 5610.437536219 -30206.93422 28850.335226425 30938.1961
Terminal value $456,668.00
PV of TV 269905.01349628

NPV 219756.72260197
s ie 2013 to 2017

owth of 5% in the sales and the other expenses to be average

the next 10 years

2017 2018 2019 2020 2021 2022

$164,233 $172,445.00 $181,067.25 $190,120.61 $199,626.64 $209,607.97

$91,149 $95,741.46 $100,528.54 $105,554.96 $110,832.71 $116,374.35

$34,489 $36,282.43 $38,096.55 $40,001.38 $42,001.45 $44,101.52
$4,106 $4,311.12 $4,526.68 $4,753.02 $4,990.67 $5,240.20
$2,825 $2,900 $2,975 $3,050 $3,125 $3,200
$132,569 $139,235.01 $146,126.77 $153,359.35 $160,949.82 $168,916.06

$31,664 $33,210 $34,940 $36,761 $38,677 $40,692

2017 2018 2019 2020 2021 2022

$20,365 $21,383.18 $22,452.34 $23,574.96 $24,753.70 $25,991.39

$27,427 $28,798.31 $30,238.23 $31,750.14 $33,337.65 $35,004.53
$56,192 $64,113 $68,423 $72,875 $77,472 $82,218
$34,508 $37,408 $40,383 $43,433 $46,558 $49,758
$21,684 $26,704.99 $28,040.24 $29,442.25 $30,914.36 $32,460.08
$69,476 $76,886.48 $80,730.81 $84,767.35 $89,005.71 $93,456.00
$1,500 $7,921 $4,310 $4,452 $4,597 $4,746

$13,467 $14,140.49 $14,847.51 $15,589.89 $16,369.38 $17,187.85

$56,009 $62,745.99 $65,883.29 $69,177.46 $72,636.33 $76,268.15

$34,325 $36,041 $37,843 $39,735 $41,722 $43,808
$804 $1,716 $1,802 $1,892 $1,987 $2,086

2017 Average through 2013 ro 201

 55.5% 55.5%
21.0% 21.0%
2.5% 2.5%
12.4% 12.4%
16.7% 16.7%
13.2% 15.5%
8.2% 8.2%

5 6 7 8 9 10

2017 2018 2019 2020 2021 2022

$21,102 $14,849 $19,574 $20,601 $21,681 $22,818

$21,102.11 $14,849.26 $19,574.01 $20,600.65 $21,681.06 $22,817.92

NPV $135,416.51

2017 2018 2019 2020 2021 2022

$229,926.66 $241,423.00 $253,494.15 $266,168.85 $279,477.30 $293,451.16 2013 as is, 2014 up by 20%, 2

$127,655.28 $134,038.05 $140,739.95 $147,776.95 $155,165.79 $162,924.08 same % as before

$48,376.57 $50,795.40 $53,335.17 $56,001.93 $58,802.02 $61,742.12 same % as before
$4,106 $4,311 $4,527 $4,753 $4,991 $5,240 same
$5,825 $5,900 $5,975 $6,050 $6,125 $6,200 initial depreciation + the incre
$58,307.40 $61,006.52 $63,836.85 $66,804.94 $69,917.69 $73,182.32

$69,347.88 $73,031.52 $76,903.10 $80,972.01 $85,248.11 $89,741.76

 $28,510.91 $29,936.45 $31,433.27 $33,004.94 $34,655.18 $36,387.94
$38,397.75 $40,317.64 $42,333.52 $44,450.20 $46,672.71 $49,006.34
$116,192 $124,113 $128,423 $132,875 $137,472 $142,218 (assuming no other capex for
34508 37408 40383 43433 46558 49758
81684 86704.98858 88040.2380049 89442.249905 90914.3624 92460.0805203979
$148,592.66 $156,959.08 $161,807.03 $166,897.39 $172,242.26 $177,854.37
$1,500 $7,921 $4,310 $4,452 $4,597 $4,746

$18,853.99 $19,796.69 $20,786.52 $21,825.85 $22,917.14 $24,063.00

$129,738.67 $137,162.39 $141,020.51 $145,071.54 $149,325.12 $153,791.37

$48,054.67 $50,457.41 $52,980.28 $55,629.29 $58,410.75 $61,331.29
$1,126.28 $2,402.73 $2,522.87 $2,649.01 $2,781.46 $2,920.54

5 6 7 8 9 10
$42,524.84 $37,221.77 $43,228.90 $45,605.78 $48,107.69 $50,740.89
32692.48111 27149.58696 29915.8536492 29943.886265 29968.4205 29989.4459440315
 2012
Growth rate = 5%
Net sales $142,528 Operating income 19%
$149,654.40

Terminal value

Average through 2013 ro 2017

2013 as is, 2014 up by 20%, 2015 up by 30%, 2016 onwards up by 40%)

same % as before
same % as before

initial depreciation + the increased amount due to new plant purchase

(assuming no other capex for the year)
Answer Q3)
The project seems to be value additive because the project with or without expansion is a positive NPV project
because as we can see that initial investment subtracted by the pv of cash flows is a positive number
and even the expansion project is a positive NPV project, hence this acquisition will add value to the shareholders of sterling
If the deal is an all cash deal it would definitely add value to the sterling shareholders but if the project has shares exchange th
shareholders would be dependent upon the exchange ratio used in the deal

Answer Q4)
There are several trends pointing toward in favor of the acquisition, because the health care industry has been growing and
in particular there are no market leaders in the germinicidal line of business.
The financial performance for the business is strong with yoy growth rates close to 5% and the operatinmg profits as huge as 1
As far as the financial is concerned the target has zero debt so we do not take over any liabilities and this increases our debt ca
It is useful because the borrowing rates are low in the market + the tax rates are high so a higher value of tax shields
Another point in favor would be the closely related product lines with the target would ensure we do not have to spend a lot o
The goal of the company has been yoy growth now because of its recent bad growth rates of as low as 2% this acquisition help
The company is not run properly and we may change the management etc to get a better control over the company

One of the issues could be the market being segmented despite our acquisition we cannot be sure if we will gain the forecaste
competition may step up and we may not get the required synergies
Secondly we are taking debt for this acquisition which increases our financial leverage so we may actually be hurt even harded
 tive NPV project

to the shareholders of sterling

e project has shares exchange the value added to the sterling

dustry has been growing and

e operatinmg profits as huge as 19%

es and this increases our debt capacity
er value of tax shields
we do not have to spend a lot on distribution channels etc.
s low as 2% this acquisition helps us achieve that as well
trol over the company

sure if we will gain the forecasted market because the

may actually be hurt even harded if the expected cash flows are not realized