Plas-Tek Industries (PTI) is in the business of manufacturing and distributing items such as
gaskets, washers, and other similar parts made of plastic. PTI is comprised of two companies:
HE Manufacturing, which is a corporation, and Plas-Tek Sales, a subchapter S company. This
bid reflects the current value of PTI, future earnings, associated risks, tangible assets as well as
intangible assets. Excess cash and investments were removed from the valuation.
Below, you will find a discounted cash flow analysis based on PTI’s historical data with a 5 year
outlook. In 1981, PTI’s revenue was $942,000. During the business analysis, Allen estimated
that the role that the CEO played would equate to a $150,000 salary. The $150,000 substituted
the CEO’s pay of $454,000. The net income, or cash flow, after calculations is $162,000.
During 1982, the interest rate spiked to around 20%. Although the discount rate is high, we use
20% for the discount rate because that was the economic outlook during that time period. This
means that the cash flow is discounted 20% each year. The growth rate of PTI is sporadic, but it
has been growing for the most part since 1976. We will assume that growth will continue at
10%.
The present value of cash flow during 1982 and the terminal value of PTI then is valued at
$1,200,625. We will use the same discount that was applied by executors of the estate since
this was a cash sale and would not accept an extended payment plan. This puts the value of
PTI at $960,500, well over the $600,000 minimum. Depending on the number of competitors
and how much Allen wants this business, the bid should be within valuation and the $600,000
minimum bid requirement. A bid for PTI at $780,000 would be between those two numbers and
would be the suggested bid price.
What was not considered in the discounted cash flow model were the contingent liabilities. Two
areas that may have a potential liability was unreasonable compensation to the founder and
accumulated earnings from HE Manufacturing’s interest-earning assets. If the IRS declared that
some of the compensation was “excessive”, it could reclassify some of the compensation as
dividends which would be taxable. There was even a greater liability if the transfer-pricing
policies between the two companies were questioned by the IRS. HE Manufacturing’s assets
could be taxable if the IRS decided that those were earnings by the company. Because these
two areas are potential liabilities that may never surface and difficult to predict or calculate what
the IRS would claim is taxable, the bid doesn’t incorporate the possible risk.
Discounted Cash Flow Analysis
CASH FLOW (CF) 1982 1983 1984 1985 1986
Revenue 942,000 942,000 942,000 942,000 942,000
Less:
Expenses 780,000 780,000 780,000 780,000 780,000
Cash Flow 162,000 162,000 162,000 162,000 162,000
COST OF CAPITAL
Cost of Capital 20.0%
PRESENT VALUE OF CASH FLOWS (PV of CF)
Year 1 Year 2 Year 3 Year 4 Year 5
Discount Factor 0.83 0.69 0.58 0.48 0.40
Present Value of Cash Flows 135,000 112,500 93,750 78,125 65,104
TERMINAL VALUE (CASH FLOW IN PERPETUITY)
Cost of Capital 20.0%
Growth Rate in Perpetuity 10.0%
Terminal Value 1,782,000
VALUE: PERPETUITY GROWTH RATE
METHOD
PV of PV of Terminal
CF Value PTI
484,479 + 716,146 = 1,200,625
Discount for Cash Sale $ 960,500
