Monmouth, Inc. Case Study

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I found the average levered equity beta from the comparable firms to be .954. I found the average debt/equity of the comparable firms to be 33.23% which I found by taking their market value debt/equity and finding the equity/value ratios and then dividing the debt by equity to get each firms debt/equity ratios and then averaged them. I then unlevered the equity beta and then re-levered it using Robertson’s capital structure:

.958/((1+(1-.40)(.3323))= .799

((1+(1-.40)(.467))(.799)=1.02

To estimate the cost of equity, I used the 30 year US treasury bond rate and the estimated market risk premium given in exhibit 7 because this time-period seemed to be representative of the life of the company.

Cost of equity= 4.10%+1.02(6%)=10.22%

To estimate the cost of debt, I used the information in exhibit 6 and 7. I estimated Robertson’s bond rating to be around a BBB because their ratios fell between A and BB rated bond ratios.

Cost of debt= 6.07% (1-.40)=3.64%

WACC= (.1022*.72)+(.0364*.28)= 8.38%

To estimate the expected future cash flows, I assumed the pro-forma statements were a reliable prediction of the future and I assumed that the growth rate of working capital would be commensurate to the growth rate of sales because working capital typically increases as sales revenues grow. Estimated net working capital is shown in exhibit 1 below. I found 2002 net working capital by subtracting current liabilities from current assets: 28-4=24. Looking at the trend in the growth rate of sales, it peaks in 2005 and then decreases slightly in 2006, and the change in 2007 in 0. I will assume that this continues into the future by looking at the trend and everything remains the same from 2006 to 2007 in the pro forma statements. I used the EBITA from the pro forma statements to start out the free cash flows, added back in the depreciation, subtracted the capital expenditures and net working capital. I assumed that there would be no regain of working capital or addition of a salvage value as the life of the company will continue into the future. I used the WACC I found previously to discount the free cash flows to arrive at an estimated present value of the cash flows between 2003 and 2006 to be $3.29. I used the no-growth perpetuity to evaluate the terminal value of $42.38. I used the no growth perpetuity because the trend in the pro forma statements seemed to indicate this would be the best method to use and the company cannot keep growing forever so I thought this would be appropriate. I found the maximum amount that Monmouth should pay for Robertson to be $57.65 per share which can be found in exhibit 2.