# The Valuation and Financing of Lady M Confections

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The Valuation and Financing of Lady M Confections

Prepared By

1. Rushab Kachhara

3. Nishtha Sah

4. Nehal Damniwala

Break Even Analysis

How many cakes would Lady M need to sell in a year in order to break even? Does this number seem feasible?

Analysis: Considering the net income to be zero and cost of goods sold to be 50%, the gross sales is predicted to be \$1,880,000. With the sale price to be \$80, Lady M needs to sell 23,600 cakes to achieve break even (Refer to workings in Exhibit 1). Bryant Park which has a similar growth rate and sales pattern, achieved sales of \$1.15 million in approximately 6 months. Based on these estimates, the projected sales could reach around \$2.30 million in one year or 28750 cakes(@\$80/cake). So, the breakeven sales @ 23600 cakes for World Trade Center Boutique seems achievable.

Assuming sales in year one is Breakeven, how quickly would sales need to grow after the first year to pay the startup costs within 5 years? Is this growth rate feasible?

Analysis: Considering the assumptions of rent, labor, utility cost and cost of goods sold, the total of fixed expenses were derived for Year 2 to Year 5. Based on this, the Total Sales from Year 2 to Year 5 was derived such that total Net income of 1 Mn USD could be recovered in this period.

Sales from Yr. 2to 5 / Sales at Year 1, gives the Future value factor of 5.5 which implies that Lady M needs to grow at constant rate 13.19% per annum after year 1 (Refer Exhibit 1), to recover the startup costs. Historically the sales growth in 2013 is 81.3% and 2014 is 46.8%, when new stores were opened. Hence an average of 13.19 % is feasible.

What is your recommendation? Should Romanisyzn open the new location in the World Trade Centre?

Analysis: With the public behavior in New York as not wanting to go too far for their needs and opportunity of targeting the corporate sales in World Trade Centre, it will be good opportunity to open the new store as it will be achieving the breakeven point in 1 year. While Romanisyzn and Tom are hoping that the Sales would grow by 20% per year, if the new location didn’t do well they might only see a growth of 5%. While, worst case scenario of 5% rate of growth would extend their payback period way beyond the desired 5 years, with the best-case scenario of 20% growth the investment can be recovered in less than 4 years. With a payback period of 5 years, the sales need to grow on an average by 13.19% which falls between the best- and worst-case scenarios. Considering that Lady M has grown consistently after opening new stores in 2012 and 2013 and sound market placement, brand value and reputation of its product, Romanisyzn should open the new store in World Trade Centre and take advantage of the growth opportunities.

Valuation Analysis

What is Lady M’s enterprise value i.e. the value of its business operations (Debt+Equity-Excess cash)? Does it matter if one uses an EBITDA multiple or a perpetuity growth formula for terminal value?

The Enterprise Value (Deriving the Terminal Value by discounting growing Free Cash Flows to perpetuity) is ~ USD 53.21 Million. The Enterprise Value (Deriving the Terminal Value to be a product of Horizon EBITDA and EBITDA Multiple of 12) is USD 72.99 Million (Refer Exhibit 3).

The Perpetuity Growth rate formula is applied to Free Cash Flows at horizon date, which is simply the Net Income + Depreciation - Capex - Increase in Working Capital. Because free cash flow to the firm captures the value of capital expenditures (Capex), it is more strongly linked with valuation theory than EBITDA. EBITDA will be a generally adequate measure if capital expenses equal depreciation expenses are almost equal and very low.

In this case, in the fifth year Capex equals the depreciation and the value is not significant, and it should not matter whether to use EBITDA multiple or perpetuity growth formula, since Capex and depreciation is not going to add any significant value to the firm, provided that the EBITDA Multiple gives a true estimate of the firm’s value.

Having said that, if we combine the two approaches we find that valuing the free cash flows at horizon assuming sales growth rate of 4% would yield a terminal value for which the EBITDA Multiple would be approximately ~ 8.15 times. Alternatively, at a terminal value based on EBITDA multiple of 12, the firm would need to grow at a rate of approx. 6.44%. Assuming an inflation of 2.5 %, this nominal growth rate would convert to real growth rate of 3.84% which appears optimistic.

If the growth rate is too optimistic it might inflate the value of the firm.

2. What do you think of Romaniszyn’s and Tom's baseline assumptions? Are they realistic?

The assumptions are reasonable because the sales growth is in line with the historical data, with no new stores the sales are expected to rise by 25% and 40% for the year when store is opened. Also it is reliable to state that expenses such as Cost of Goods Sold and SG&A have been considered as per sales percentage. Even when there is no new expansion a minimal percentage has been allocated for Capital expenditure, for purchase of any fixed assets over the years.

3. Do you think they should take the Chinese investors' offer? Why/why not?

We think that Lady M should not take Chinese Investor offer because as per the case Lady M has no immediate plans to expand in near future therefore the \$10 million will lie ideal. Currently only \$1 million is required to open store at WTC, which will be received within 5 years as per payback period. Another reason being by accepting the fund from the investor Lady M will lose access to the potential market i.e. China, as the franchising right must be transferred to Chinese investor. Finally, Lady M would have to give up her stake almost 12% (EBITDA multiple method) to 15.9% (Perpetuity method) (Assuming that the Cash in the Balance Sheet is not used in operations) (Refer Exhibit 4), which is greater than the low interest rate mentioned in the case.

Exhibit – 1

2014 2015 2016 2017 2018

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