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C 13

1) Burton Sensors should purchase new thermowell machines as the NPV is positive, considering the long economic life and need to increase production in the consolidating market. 2) Burton should sell shares to the private investor to raise capital, which will help meet bank requirements and fund growth, despite short-term share price dilution. 3) Acquiring Electro-Engineering is only recommended if the DCF model considers terminal value, as it provides growth opportunities but the NPV is negative without terminal value.

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40 views6 pages

C 13

1) Burton Sensors should purchase new thermowell machines as the NPV is positive, considering the long economic life and need to increase production in the consolidating market. 2) Burton should sell shares to the private investor to raise capital, which will help meet bank requirements and fund growth, despite short-term share price dilution. 3) Acquiring Electro-Engineering is only recommended if the DCF model considers terminal value, as it provides growth opportunities but the NPV is negative without terminal value.

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Case Summary:

Company Background: Amy Marshall is the founder of AMI labs which was a temperature sensor
manufacturer. In 2004, she acquired Burton Sensors which designed and manufactured a large variety o
temperature sensors for various industries including oil and gas, automotive, food processing, medical, etc.
Having grown initially with internal cash flows, Burton acquired outside funds to finance further growth in
the form of an IPO in 2011 (Equity) and an increased line of credit in 2013 (Debt).

Sensors Market: The market for temperature sensors was classified into 7 major segments based on
product type with Fiber-optic sensors expected to show the highest growth in the future. The US sensor
industry had a fragmented and competitive nature with about 4000 OEMs. While larger companies
possessed a diversified portfolio alongside a large distribution network, smaller firms like Burton relied on
customer relationships and customized products to stay competitive. Further, they looked for network
expansion and experienced sales representatives while managing large inventory costs.

Overall industry expected CAGR during 2017-23 was 4.5% to reach $6.86 billion in size by 2023.
The fiber-optic sensor market expected CAGR was 15% to reach $3.5 billion by 2024 because of a large
demand for accurate measurement in harsh environments from multiple industries (such as defense,
chemical, metals, medical, and construction) and high R&D investments.

Concern - 1: BANK Requirements


Burton’s bank provided it with $4.58 million in revolving credit line alongside further loans at 2%
above prime rate. This was done with the expectation of an industry-wide change where strong firms like
Burton would have increased operating cash flows which would over time reduce their liabilities to equity
ratio.
Since Burton’s sales grew faster than its cash flows, the firm relied on high level to working capital
to sustain its growth. With total liabilities of 5x the net worth and bank loans equalling 96% of total accounts
receivable and inventory, the bank was worried about the company’s dependence on short term debt to
finance its operations.

Bank’s planned restriction on future loans:


1. Outstanding bank loans<= 75% of accounts receivable and inventory
2. Total liabilities <= 3x the book value of equity

Marshall had planned for a 1:1 ratio of Burton’s interest-bearing debt and book value of equity.

Concern - 2: Thermowell Machines


Thermowells were a major component of resistance temperature detectors (RTDs) and provided
numerous advantages in the quality and longevity of sensors. But Thermowells formed a major part of the
sensor’s production cost.
Burton spent $1.4 million in 2016 to purchase Thermowells from external sources as its capacity
fulfilled only half of its production needs.

Details related to purchase offer of 4 Thermowell machines:


Cost of purchase = $600,000
Economic life of machines = 7 years
Annual cost of operators for machines = $170,000
Annual material and space cost = $780,000
Average increase in net working capital needs during equipment’ life = $650,000

Concern - 3: New Common stock Issue


Burton needed additional capital for the following reasons:
1. Maintain inventory for a potential increase in customer orders
2. Finance R&D for new product development

Burton stocks current price on the OTC market was $4.75. Currently, Burton’s shareholding structure
included Marshall and her family, firm employees and other retail investors.
The 450,000 share acquisition offer from a private investor at $3.5 a share was the best Marshall could get
as per the advice of her friend in financial services. The cost associated to the deal stood at 50,000 shares.

Concern - 4: Acquiring Electro-Engineering Inc.


EE was a fiber optic sensor manufacturer with less expensive and more durables sensors in
comparison to the competition. Marshall observed that the inefficiency in EE’s operations and the potential
synergies between a combined Burton and EE.
Further, the strong balance sheet of EE attracted Marshall. EE’s owner was willing to sell the firm
at a valuation of 10x EBITDA of 2016 in exchange for Burton’s shares valued at $4.75 per share.
10-year US treasury note yield = 3%
Equity risk premium = 5.8%
Baa Rated corporate bond yield = 4.8%

Issues Identified:
1. Whether to purchase new thermowell machines or not?
2. Whether to raise additional capital by selling shares to the private investor given the offer?
3. Whether to acquire Electro-Engineering Inc. or not?

Solution:
Issue -1: Purchase New Thermowell Machines
Solution: Yes, we should purchase new thermowell machines as we have calculated the NPV of the
cashflows post considering the costs related to purchase of thermowell and it came out to be positive.

In addition, the thermowell machines have long economic life, therefore making them cost
effective. Being in a highly competitive environment wherein the market is consolidating, Burton needs to
increase its production and thus purchasing new thermowell machines is logical financially and
strategically.
Figure 1: Calculation of NPV of Thermowell
(Assumed savings and material cost to increase by 4.50% (CAGR) of the cost given in 2016)

Issue - 2: Sell Shares to Private Investor


Solution: Yes, we should sell the shares to the private investors as through the capital raised by selling
4,50,000 shares of the company at $3.50 (which is at a discounted price of 26.31% lesser than the OTC
price of $4.75) and paying the consulting firm in 50,000 shares, we achieve the following:
Pros
• The target of outstanding loan to be 75% of the company’s accounts receivable and inventory by
reducing borrowing
• The bank’s target of liabilities to BV of equity not exceeding 3:1 as well as Marshall’s leverage
ratio target of 1:1
• Availability of funds to fund growth opportunities.

Cons
• With this transaction, a greater number of shares are issued in the market reducing the EPS and
therefore the share price will also fall.

Figure 2: Calculation for making decision of selling shares to Pvt. Investor


Issue - 3: acquire electro engineering inc.
Solution
YES: IF terminal value is considered then the NPV becomes positive and thus we should acquire
EE. It promises growth opportunity and increase shareholder’s value. Since the market is consolidating,
Burton being a smaller player needs to grow its market size by acquiring EE (Fiber Optics Industry is
growing at 15% CAGR).

NO: IF terminal value is not considered then the NPV becomes negative and thus we should not
acquire EE. It will not increase the shareholder’s value.

Conclusion:
Thus, we conclude that the company should
• Purchase the new thermowell machines
• Raise capital by issuing new common stock and selling it to private investor
• Depending on the DCF modelling (Terminal value consideration) the acquiring decision should be
made.
APPENDIX

• WACC Calculation

• DCF Calculation (With Terminal Value=0)

• DCF Calculation (With Terminal Value)

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