FINANCIAL MANAGEMENT II

PRA 1- Burton Sensors Inc.

Submitted to
Prof. A Kanagaraj

Submitted by
BM Section A

Aashna Gupta BJ22002

Kartik Pawar BJ22019
Jhalak Agrawal L22002
Aman Sharma L22004

Submitted on
12.01.2023

Executive Summary
Burton Sensor is a company that manufactures and designs temperature sensors. Its offerings
include a “variety of higly accurate and custom Thermocouple sensors, RTDs, temperature
probes and transmittors”. Started by Amy Marshall by the name of AMI labs, it acquired Burton
Sensors in 2004, in order to meet the increasing demand. It is a fast-growing firm which intially
relied on organic growth. In 2011, they went for IPO, and later realized they need much more
finances for futher expansion. Now, it has reached a point of fully utilizing its debt capacity.
The company has reached it’s debt capacity and therefore it intends to seek other financing
options to sustain their growth. Because of this the president of the company wants to go for
equity financing to maintain its growth. If the company wants to go for borrowing from bank,
it must also fullfill certain conditons which it currenly does not. Finally, the president has three
options of either purchasing new machines called Thermowells or accept the offer of a private
investor and issue new stocks or acquire Electro-engineering Inc. Now it is upto the discretion
of the president of chosing a particular alternative by evaluating different available options at
the hand.

List of Issues Identified

1. Should Marshall purchase the thermowell machines?
2. Should Marshall accept the offer of the private investors and issue new equity?
3. Should Marshall acquire Electro-Engineering Inc. (EE)?

EVALUATION OF CRITERIAS:

Bank’s Request:
Both of the coveneants of the bank need to be satisfied in order for the bank to finance the
firm’s expansion.
Maximise Growth potential:
When looking for a suitable option for growth, the firm needs to take into account the growth
potential of it.

EVALUATION OF ALTERNATE SOLUTIONS:

OPTION 1: Should Burton Purchase New Thermowell Machines?

For this option, we need to calculate the NPV of the investment.
New costs:
Firstly, we need to consider that $1.4 million spent that was cash outflow is now
saved and becomes an implicit inflow.
Machine purchase outflow would be $600K*4=$2400K
Another added cost would be operator hiring cost = $170K*2 = $340K.
Material and warehouse rent = $780K.

The depreciation method used is SLM, calculated over 7 years, amounting to

600K/7=$85.7143K per Anum.
Net working capital outflow = $650K at start of y1, adjusted as inflow at end of y4.
 Given the present cash, we subtract / add the above and calculate the cash flows.
These still need to be discounted.
For this we take the help of WACC. First, we calculate Ke.

Rm = 5.8 Rf = 3%

Industry Beta is calculated with the help of Exhibit 4 comparative data. Changed from
levered to unlevered and finally levered according to Burton, 3.6.

Now, we calculate the WACC using this beta value and other given variables which
comes out as ~7%.
After discounting using the above WACC, we find the NPV coming close to ~459K
Here is comes out to be negative, less than 600K.
Hence, this option is not feasible. Burton should not purchase the machines.

OPTION 2 : Should Marshall accept the offer of the private investors and issue new equity?

It is not straightforward for the firm in a sense for raising equity capital through the
issuance of shares as their stock was listed on the OTC market. Therefore, Burton
Company will have to rethink whether to seek out private investors in order to raise
more money.
Moreover, according to a friend of Marshall, it was conveyed that it would be a
troublesome and very unrealistic thing for the company to sell out a decent amount of
stocks directly in the market. The company has been approached by an
investor(private) who has agreed to offer a price of 3.5 per share in exchange for
450K shares of the company. The only red flag with this option is that there might be
some terms which Burton has to agree upon with the investors agreement and the
consulting company would take their take as well if the deal gets closed. Burton,
being unable to issue new shares, should opt for this option being the most rational.
Furthermore, we see that when we raise the money through this option both the
covenants of the banks are satisfied.

For covenant 1, bank loan stands at $5080K vs AR + Inventory at $5823K, making it

87%. The target ratio is 75%. For that, an additional amount of $713K is required.
The cash proceeds are $1575K, easily covering the dearth of capital.

For Covenant-2, we have total liability at 9386.4. And the total equity becomes
3866.8 after issuance. The L/E ratio becomes 2.4, satisfying the second covenant.
(Previously it stood at 4.4)

OPTION 3 : Should Marshall acquire Electro-Engineering Inc. (EE)?

The acquisition of EE will lead the company to enter into the optical fibre segment.
The EBITDA of Electro-Engineering Inc is $461,800 for the year 2016. After
 acquiring EE, the CoGS will reduce by 39.2%. The proposed offer of acquiring EE is
completely out of sync with it’s EBITDA multiplier being a perfect 10, i.e.,
$6867,000.
EE comes up with a novelty in technology which can aid up the production process
and make it more cost efficient and economical. They have to also take into
consideration the bank restrictions imposed on them. In the end, it would be a
decision for Marshall to make that whether the company intends to go with being the
majority shareholder or get away with it. We need to explore further.
For this option, DCF valuation of the company was carried out.
Income statement was projected as simple average growth rate.
For the next projection, we have used ppe as revenue % and kept some figures
constant.
The EV comes out to be ~8400K.
And the equity value comes out as ~8446K
This is more than that of the purchase value.
Hence, the company should be acquired.

CONCLUSION:

In the first option the NPV of the machines came out to be less than the actual investment, so
the first one was rejected.
In the second option, after issuing stock to the private investor, it could grow more by
satisfying both the covenants of the bank.
Finally, in the third option, the Equity value came out to be more than the purchase value,
meaning that the EE was undervalued and hence must be bought.

Evaluating the above three alternatives, the most optimum strategy for the company would be
to either go for private placement or to acquire EE.
Since both the options are exclusive to each other a combination of both could also be applied
and taken into consideration.