Analyzing a Management Buyout Using the Statement of Cash Flows
The management of Dover Corporation claims that the securities market undervalues shares of its company. They propose to take it private by means of a leveraged buyout. ManagementĂ˘â‚¬â„˘s proposal contains the following features:
1. The leveraged buyout is expected to yield additional after-tax annual interest costs of $200,000.
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2. To make Dover Corporation competitive, management plans to undertake:
a. Annual investments in equipment of $180,000.
b. Annual buildups in inventory of $60,000.
3. Management expects no additional financing demands beyond that listed in (1) and plans to use cash generated by operations as the primary financing source.
At the end of Year 8, management requests you to analyze the feasibility of their proposal. They provide you with the financial data listed below to assist in your analysis.
1. On January 2, Year 8, Dover sold equipment costing $45,000, with a carrying amount of $28,000, for $18,000 cash.
2. On March 31, Year 8, Dover sold one of its marketable equity securities for $119,000 cash. There are no other transactions involving marketable equity securities.
3. On April 15, Year 8, Dover issues 20,000 shares of its common stock for cash at $13 per share.
4. On July 1, Year 8, Dover purchases equipment for $120,000 cash.
5. DoverĂ˘â‚¬â„˘s net income for Year 8 is $305,000. Dover pays a cash dividend of $85,000 on October 26, Year 8.
6. Dover acquires a 20 percent interest in Top CorporationĂ˘â‚¬â„˘s common stock during Year 5. There is no goodwill attributable to the investment, which is accounted for using the equity method. Top reports net income of $150,000 for the year ended December 31, Year 8. No dividend is paid on TopĂ˘â‚¬â„˘s common stock during Year 8.
Prepare an analysis evaluating the financial feasibility of managementĂ˘â‚¬â„˘s plans. (Hint: Prepare a statement of cash flows. Use the indirect method.)