MM 5009

FINANCIAL MANAGEMENT
YEATS VALVES AND CONTROL INC.

Group 10

Diah Ayu Ismandari (29115111)

Dzaki Iryanto (29115148)

Erfandi Al Asra (29115079)

Fatharani Sholihat (29115154)

Silvy Puspita Oktavianty (29115125)

Siti Nuur Fauziyah Anbarsari (29115020)

MASTER OF BUSINESS ADMINISTRATION

SCHOOL OF BUSINESS AND MANAGEMENT

INSTITUT TEKNOLOGI BANDUNG

2016

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 EXECUTIVE SUMMARY

Yeats Valves and Control Inc., headquarter at Innisfree, California, was principally engaged in the
manufacture of speciality valves and heat exchangers. The company was an outgrowth of a small
company organized in 1980 for engineering and developmental work on experimental heat exchanger
product. In 1987, Yeats Va;ves and Control Inc. Was organized to acquire the patents and properties
borh owned and leased, of the engineering corporation. Bill Yeats is founder and CEO of Yeats
Valves. There were 560 stochoders of Yaets Valves and Control Inc. And roughtly 70 percent of the
stock was held within the board of directors and their family, including 20 percent owned by Auden
Company and 40 percent owned by Bill Yeats.
In early May 2000, W.B. “Bill” Yeats, chairman, CEO, and founder of Yeats Valves and Control
Inc., met Edna Millay, an investment banker and member of Yeats Valves’ board of directors to
discuss the proposed acquisition of Yeats Valves by TSE International Corporation. Serious
negotiations for combining the two companies had started in March, following casual conversations
dating back to late 1999. Before entering final negotiations with Tom Eliot, CEO of TSE International
Corporation, Yeats wanted to hear Edna Millay’s opinion of the TSE International proposition and
obtain her advice about price and negotiation strategy.

I. Objective
To determine the decision about the merger between Yeats Valves and Control Inc. With TSE
International, wether it is good to the company to merger or not. Will it bring benefit to company? We
use ADCF, PR Ratio, Book Value, and Market value to analyze it.

II. Analysis
2.1 Yeats Valves and Control Inc
2.1.1 WACC Yeats Valves and Control Inc

Market Value of Equity = Current Share Price x Average Shares Outstanding

= $ 39,8 x $ 1.440.000 million
= $ 57.312.000 million

Equity = $ 57.312.000 Millions

Debt =$0

A. Cost of Equity
rs = Rf + [β x (rm – Rf)]
Rf = risk-free rate of return
Rm = market return

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 Β : 1,5
Rf : 5,98 %
Premium risk (rm – Rf ) : 5,5 %
rs = Rf + [ β x (rm – Rf) ] : 14,23%

Debt of Yaets Valves is zero (0) so in this company they use 100% of equity. It’s because
Yealts Valves is a small company. If, them is a huge company it’s not good to use 100% equity in
their business.

D
WACC Yeats Valves=K d (1−t ) × + K e × E/(D+ E)
D+ E
= 0% + 14,23% × 100 %
= 14,23%

2.1.2 Growth Rate Yeats Valves and Control Inc

ROE = EACS / Total Equity

= $ 5.575 / $ 36.764
= 15,16%
Dividen per share
DPO (Dividen Payout Ratio) = x 100 %
Earning per Share
1,6
= x 100 %
3,87
= 41,34 %
Growth Rate = ROE × (1 – DPO)
= 0,1516 x (1- 0,4124)
= 8,9 %

Table 1. Free Cash Flow 1999 – 2004 (in Thousands)

Depreciatio Capital Working
Year Net Income Free Cash Flow
n Expenditure Capital
$
1999 $ 5.575 1.508 $ - $ - $ 7.083
$
2000 $ 8.347 1.660 $ 1.826 $ 3.492 $ 4.689
$
2001 $ 8.634 1.828 $ 2.011 $ 3.867 $ 4.584
$
2002 $ 9.792 2.012 $ 2.213 $ 4.289 $ 5.302
$
2003 $ 11.106 2.212 $ 2.433 $ 4.757 $ 6.128
$
2004 $ 12.576 2.432 $ 2.675 $ 5.273 $ 7.060

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 FCF 2005
Value of FCF 2005 =
r a−g FCF

7.060.000 x (1+0,089)
=
0,1423−0,089

= $ 144.246.529

Total FCF 2004 (Terminal CF) = $ 7.060 .000 + $ 144.246.529

= $ 151.306.529
Table 2. Calculation of the Value of the Entire Company for Yeats Valves and Control Inc.
Year FCF (1+ra)t PV FCF
1999 $ 7,083 1.142 $ 6,201
2000 $ 4,689 1.305 $ 3,594
2001 $ 4,584 1.491 $ 3,075
2002 $ 5,302 1.703 $ 3,114
2003 $ 6,128 1.945 $ 3,151
2004 $ 151,306 2.222 $ 68,104
Value of entire company, Vc = $ 87,239
Value per Share = $ 61

2.2 TSE International

2.2.1 WACC TSE International

Table 3. Proportion
Prefered Stock $ 27.783.200 2,31%
Common Stock $ 1.053.265.265 87,76%
Long Term Debt $ 119.100.000 9,92%
Total Capital $ 1.200.148.465 100,00%

A. Cost of Equity

rs = Rf + [β x (rm – Rf)]

Rf = risk-free rate of return

Rm = market return
Β : 0,85
Rf : 5,98 %
Premium risk (rm – Rf ) : 5,5 %
rs = Rf + [ β x (rm – Rf) ] : 10,65 %

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B. Cost of Prefered Stock

Cost of Prefered Stock = 2%

C. Cost of Debt

ri = rd x (1 – T)
rd = interest rate
T = Tax (we asumed tax is 40%, based on tax in 1999)
rd : 9,6 %
Tax : 40 %
ri = rd x (1 – T) : 5,76 %

The cost of debt for TSE International before tax is 9,6% and the cost of debt after tax for
TSE International is 5,76%.

WACC TSE International=¿5,76% ×9,92% + 10,65 % × 87,76 % + 2% x 2,31%

= 9,96%

2.2.2 Growth Rate TSE International

ROE = EACS / Total Equity

= $ 164.041 / $ 895.737
= 18,31%
DPO (Dividen Payout Ratio) = 56,2 %
Growth Rate = ROE × (1 – DPO)
= 0,1831 x (1- 0,562)
= 8,02 %
Table 4. Free Cash Flow 1999 – 2004 (in Thousands)
Cash Dividens Free Cash
Year Net Income Depreciation
Declared Flow
1999 $ 164.041,00 $ 26.800,00 $ 92.238,00 $ 98.603
2000 $ 177.197,09 $ 28.949,36 $ 99.635,49 $ 106.511
2001 $ 191.408,29 $ 31.271,10 $ 107.626,25 $ 115.053
2002 $ 206.759,24 $ 33.779,04 $ 116.257,88 $ 124.280
2003 $ 223.341,33 $ 36.488,12 $ 125.581,76 $ 134.248
2004 $ 241.253,31 $ 39.414,47 $ 135.653,42 $ 145.014

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 FCF 2005
Value of FCF 2005 =
r a−g FCF

145.014 .000 x (1+0,0802)

=
0,0996−0,0802

= $ 8.074.439.320

Total FCF 2004 (Terminal CF) = $ 145.014 .000 + $ 8.074.439.320

= $ 8.219.453.320

Table 5. Calculation of the Value of the Entire Company for TSE International
Year FCF (1+r a )t PV FCF
1999 $ 98.603 1,100 $ 89.672
2000 $ 106.511 1,209 $ 88.090
2001 $ 115.053 1,330 $ 86.535
2002 $ 124.280 1,462 $ 85.009
2003 $ 134.248 1,608 $ 83.509
2004 $ 8.219.453 1,768 $ 4.649.803
Value of entire company, Vc = $ 5.082.618
Value per Share = $ 81.1
       

2.3 Merger Valuation

2.3.1 WACC after Merger

Table 6. Proportion
Prefered Stock $ 27.783.200 2,21%
Common Stock $ 1.110.577.265 88,32%
Long Term Debt $ 119.100.000 9,47%
Total Capital $ 1.257.460.465 100%

Common stock in this part is the sum of Yeats Valves and Control Inc. And TSE International capital.

D. Cost of Equity

rs = Rf + [β x (rm – Rf)]

Rf = risk-free rate of return

Rm = market return
Β : 0,85
Rf : 5,98 %
Premium risk (rm – Rf ) : 5,5 %
rs = Rf + [ β x (rm – Rf) ] : 10,65 %
E. Cost of Prefered Stock

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Cost of Prefered Stock = 2%

F. Cost of Debt

ri = rd x (1 – T)
rd = interest rate
T = Tax (we asumed tax is 40%, based on tax in 1999)
rd : 9,6 %
Tax : 40 %
ri = rd x (1 – T) : 5,76 %

So the cost of debt for TSE International before tax is 9,6% and the cost of debt after tax for
TSE International is 5,76%.

WACC TSE International=¿5,76% ×9,47%) + (10,65 % × 88,32%) + (2% x 2.21%)

= 10%

2.3.2 Growth Rate after Merger

ROE = EACS / Total Equity

= ($ 164.041 + $5.575)/ ($ 895.737 + $ 36.764)
= 18,19%
DPO (Dividen Payout Ratio) = Average(DPO Yeats Valves+ DPO TSE International)
= ¿56,2%)/2
= 48,77%
Growth Rate = ROE × (1 – DPO)
= 0,1819 x (1- 0,4877)
= 9,32 %
Table 7. Free Cash Flow 1999 – 2004 (in Thousands)
Free Cash Flow Free Cash Flow Free Cash Flow
Year
Yeats Valves TSE International Merger
1999 $ 7.083 $ 98.603,00 $ 105.686
2000 $ 4.689 $ 106.510,96 $ 111.200
2001 $ 4.584 $ 115.053,14 $ 119.637
2002 $ 5.302 $ 124.280,40 $ 129.582
2003 $ 6.128 $ 134.247,69 $ 140.376
2004 $ 7.060 $ 145.014,35 $ 152.074

FCF 2005
Value of FCF 2005 =
r a−g FCF

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 152.074 .000 x (1+0,0932)
=
0,1−0,0932

= $ 24.448.131.882

Total FCF 2004 (Terminal CF) = $ 152.074 .000 + $ 24.448.131.882

= $ 24.600.205.882

Table 8. Calculation of the Value of the Entire Company for TSE International
t
Year FCF (1+r a ) PV FCF
1999 $ 105.686 1,100 $ 96.078
2000 $ 111.200 1,210 $ 91.901
2001 $ 119.637 1,331 $ 89.885
2002 $ 129.582 1,464 $ 88.507
2003 $ 140.376 1,611 $ 87.162
2004 $ 24.448.132 1,772 $ 13.800.333
Value of entire company, Vc = $ 14.253.866
Value per Share = $ 222.3

2.4 P/E Ratio

P/E ratio reflects the amount investors are willing to pay for each dollar of earnings.
The average of P/E ratio in certain industry can be used as a guide to a firm’s value. The
price/earnings multiple approach is a popular technique used to estimate the company’s share
value, it is calculated by multiplying the firm’s expected EPS by the average P/E ratio for the
industry.

Table 9. PE Ratio
P/E in the Industrial P/E in the Industrial
EPS of Yeats EPS of TSE
Machinery Sector Machinery Sector
3,87 8,2 2,23 8,2
10,3 10,3
11 11
14,6 14,6
16.3 16,3
7 7
10,7 10,7
10,4 10,4
Average P/E 11,063 Average P/E 11,063
Value per Value per share
42.812 24.669
share for Yeats for TSE

Based on the table above, we can see Yeats’s PER is higher than TSE’s

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2.5 Book Value
To calculate book value per share, we used the following formula.

Σ assets−Σ liabilities
Book Value per Share=
Σ shares o utstanding

Table 10. Book Value per Share Yeats and TSE

  Yeats Valves TSE International
Total Assets $ 42.124.000 $ 1.245.825.000
Total Liabilities $ 5.360.000 $ 350.088.000
Total Shares Outstanding $ 1.440.000 $ 62.694.361
Book Value per share $ 25,53 $ 14,29

From table above, we can see that the book value per share from the Yeats is higher
than TSE’s.

2.6 Market Value

250 222.3
200
150
100 81.1
61
50
0
Yeats Valves TSE Merger

Value Per Share ($)

Graph 1. Value per Share ($)

Based on exhibit 7, market value for Yeats on May 1, 2000 is $39.75, and market
value for TSE International is $21.98. It shows that market price of Yeats is higher than TSE.
Which means, the demand for Yeats share are higher than the TSE.
From the explanation above, we can conclude that the merger between Yeats and TSE
will be benefit for both of them. It can be seen from the value per share that was resulted after
merger. The DCF calculation above shows us that the value of the merge company is bigger
than the sum of value of each company before merger (Graph 1). It means that there will be a
good synergy. So we need to calculate the minimum stock price.

Table 11. Minimum Stock Price

Value Weighted

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 DCF $ 61 60% $ 36.35
PER $ 42,81 20% $ 8.56
BV $ 25,53 10% $ 2.55
Market Price $ 128.92 10% $ 12.89
Minimum Stock Price $ 60.36

We also calculated the amount money that TSE has to pay to merger with Yeats. Here
the calculation,
Yeats market capitalization = Minimum stock price x Total shares outstanding
= $ 60.36 x 1.440.000
= $ 86.918.400

III. Conclusion and Recommendation

3.1 Conclusion
Based on the calculation and analysis above, we can conclude that:
1. The value of the company of the Yeats after merger with TSE International is $
14.253.866
2. Minimum stock price that Yeats should ask to ensure that its stockholders profit from
that merger is $ 60.36
3. From the Merger, we think that the two companies can get more benefit. For Yeats,
they can have a new managerial successor, funding for R&D, and knowledge of large
scale management & marketing. On the other hand for TSE, they can get new patents,
and new products possibilities.
3.2 Recommendation
Our recommendations are:
1. Yeats should merger with TSE International
2. TSE also has to consider that if they merge with Yeats they are facing another
problem, which is Bill Yeats retirement. TSE has to make sure that after Bill Yeats
retires, the company will run as good as now. Because until now, the decision maker
of Yeats Inc. was held by Bill Yeats as CEO of Yeats Valves. The success factor from
Yeats Inc. until now is Bill Yeats himself. Yeats should think about the employment
conditions too
3. Facing that situation, Yeats should apply the knowledge management, which he
should share his knowledge to the employee. So, the knowledge can be transferred to
the new generation of Yeats Inc

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4. They must create a database system to improve their company performance.

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