Reference no: EM133056591

Problem:

You work at a large, privately held consulting firm. Your boss has come to you and asked to you evaluate a potential acquisition. Specifically, she has told you that the leader of the targeted practice, Mr. Smith, has proposed an acquisition price of $2.0M. She wants to know if, at this price, the acquisition makes sense for your firm. You are to perform a DCF valuation of Mr. Smith's consulting practice. The required data to perform this analysis is listed below. 

Hint: You will need to calculate an appropriate discount rate (including any size premiums, etc.), free cash flows, and a terminal value. You will then have to discount the cash flows and terminal value to a present valuation.

Size of practice: 6 people

1. Smith: Bill rate $750/hour; expected chargeability = 60%; salary = $1,250,000
2. Employee 1: Bill rate $550/hr; expected chargeability = 75%; salary = $300,000
3. Employee 2: Bill rate $375/hr; expected chargeability = 80%; salary = $180,000
4. Employee 3: Bill rate $325/hr; expected chargeability = 80%; salary = $165,000
5. Employee 4: Bill rate $295/hr; expected chargeability = 90%; salary = $125,000
6. Employee 5: Bill rate $265/hr; expected chargeability = 90%; salary = $95,000
7. Giveaways: $425,000 per year (income Mr. Smith generates each year, but can't do himself. He could bring this income to a larger firm. Salary necessary to earn that missed income would be = $95,000

Mr. Smith has been in business for 20 years and has had steadily growing cash flows during this time.

Potential workable hours in 1 year = 2,000

Date of acquisition = January 1, 2022

Annual office expenses = $350,000

Risk free rate (US Treasuries)

1. 3 mo    = 1.69%
2. 1 yr      = 2.27%
3. 2 yr      = 2.52%
4. 5 yr      = 3.24%
5. 10yr     = 3.96%
6. 20yr     = 4.59%

Expected market return

1. 1 yr = 6%
2. 2 yr = 6.9%
3. 3 yr = 7.0%
4. 4 yr = 7.3%
5. 5 yr = 7.5%
6. 10 yr = 8.5%
7. 20 yr = 8.7%

Public Consulting Firm Betas:

1. Company 1 = .80
2. Company 2 = -.04
3. Company 3 = .89
4. Company 4 = .87
5. Company 5 = .92

Risk premium (size premium) for solo practice =

- 0%

- 22.5%

- 100%

Tax Rate = 21%

Revenue growth rate = 5% per year for 5 years

Cost growth rate = 3.5%

Growth into perpetuity =

1. -50%
2. 0%
3. 2%
4. 10%
   1. There are no changes in NWC expected for Mr. Smith to continue his practice
   2. There is nothing to depreciate or amortize