Icahn Case Study

CASE STUDY- FIRM VALUATION

Karl Icahn has hired you to evaluate the Carob Inc. The company has been in existence since 1978. It is a telecommunication firm that specializes in using internet protocols for business communications. Its stock is currently traded on the NYSE. The original founder of the company, Ms. CPU, recently retired and she owns 5% of the shares outstanding. Management owns another 5%. You observe the following information regarding its capital structure.

Coupon Market Units Out-

Security Rate Bk. Value Maturity Price standing

Senior Bonds 8% $ 30,000,000 10 years $1,000 30,000

Debentures 9% $ 30,000,000 10 years 950 30,000

Pref. Stock 12% $ 50,000,000 - 100 500,000

Comm. Stock $100,000,000 - 40 4,000,000

Retained Earnings $ 75,000,000 - - -

All interest and dividends are paid annually. The expected common stock dividend is $6 per share in perpetuity. Assume a tax rate of 40%. You estimate that if Mr. Icahn is able to take control of the firm, Carob Inc.’s profitability will dramatically improve. In particular, you estimate that beginning next year, the firm will enjoy sales of $150 million. Costs are expected to be 40% of sales. To continue the profitability of the company, the firm must maintain a continuous long-term investment in R&D (net of taxes) equal to 10% of sales, and investment in working capital (equivalent to change in working capital) of 5% of sales. The firm has very few tangible assets and therefore its annual depreciation expense is minimal. You believe the firm’s sales growth is 6% per annum. What is the maximum stock price you recommend that Mr. Icahn offer?

First step – calculate weighted average cost of capital

Security Class Market Value Proportion Cost of Capital Contributing Costs

Senior Bonds $30 million .112 4.8% .538%

Debentures $28.5 million .106 5.9% .625%...