Allen Lane’s decision to acquire Plas-Tek Industries (PTI) is intriguing since the business appears to be a good match with Lane’s work experience and interest. As a manufacturer, PTI has been able to create large margins and high cash flow under Harry Elson’s leadership.
However, significant risks are prevalent in acquiring PTI. First, more one-third of PTI’s sales originated from five companies and it is uncertain that without Harry Elson’s personal efforts if their patronage will continue. Secondly, the bank valuation of PTI ($600K) appears inflated as the bank’s valuation is notably more than PTI’s book value ($292K), calculated with an inflated price/earnings multiple for a company with no proprietary …show more content…
According the bank, Lane needs $600K to submit a bid to acquire the PTI through a stock purchase. However, the bank’s valuation is calculated using an inflated price/earnings multiple and does not account for the contingent liabilities. The P/E multiple that the bank used in its valuation is notably higher than expected for a company that does not have a proprietary product. Applying a market-based P/E multiple of 4X, the 20% cash sale discount and a $90K discount accounting for potential tax liability regarding Elson’s compensation (alternative 1), PTI should be worth $450K. While this price is notably higher than PTI’s book value, it is more realistic than the bank’s valuation. Since Lane and partner Dan Ray personally will finance $200K of this transaction, they need $250K to complete the stock purchase. Therefore, the financial need is $275K.
Considering that PTI currently has low liabilities and significant cash flow, Lane and Ray should seek debt financing. However, PTI is limited by having $92K in land/buildings and $150K in accounts receivable