Case Study: Clean Water Case

The following tables show the firm's current balance sheet and income statement (in EUR 1'000). The values shown in these statements are free of extraordinary events. Also, all non-operating assets that the firm has accumulated under the previous owner (in particular excess cash) have been included as these assets would not be part of the transaction.

Based on a careful analysis of the firm's historical financial statements as well as extensive discussions with the current owner, some business consultants, and bankers, the buyer came up with the following assumptions for Clean Water's financial plan for the coming 9 years:

Income statement (all EUR values in 1'000):

• Net revenues: 3'321 during Year 1. Thereafter, because of a geographic expansion, Net revenues are expected to increase by 50 in Year 2, 100 in Year 3, 150 in Year 4, 200 in Year 5 and 250 in Year 6. After Year 6, Net revenues are expected to grow at the annual rate of inflation of 1%.
   
• Purchase of material: 41% of Net revenues (historical average)
   
• Personnel expenses: 30% of Net revenues in Year 1. Thereafter 25% of Net revenues (historical average)
   
• Other operating expenses: 11% of Net revenues (historical average)
   
• Depreciation: 50% of book value of (Fixed assets at the beginning of the year + Net investments)
   
• Tax rate: 21% on Earnings before taxes (historical average).
   
• Restructuring costs: The succession will bring some one-time restructuring charges of 200 (before taxes) in Year 1.

Balance sheet (all EUR values in 1'000):

• Excess cash: Clean Water's dividend will be set equal to the total debt payments the new owner has to make. For planning purposes, any extra residual cash flow will be added to excess cash.
   
• Operating cash: 2% of Net revenues (historical value)
   
• Accounts receivable: 8.3% of Net revenues (historical value)
   
• Inventory: 6% of Net revenues (historical value)
   
• Other operating assets: 2.2% of Net revenues (historical value)
   
• Fixed assets: Fixed assets (year start) + Net investments - Depreciation. Given that the depreciation rate is 50% (see above), the book value of Fixed assets is:
  0.5×(Fixed assets (year start) + Net investments). See below for projected net investments.
   
• Net investments: 100 in Year 1; 75 thereafter
   
• Accounts payable: 4.6% of Net revenues (historical value)
   
• Other operating liabilities: 3.0% of Net revenues (historical value)
   
• Revolving credit line: The firm has a credit line of 100 with a local bank. It will draw on this credit line to avoid that Excess cash turns negative. The interest rate on the credit line is 6%.
   
• Share capital: Constant at 100. If Clean Water's cash flows and the revolving credit line of 100 are insufficient to pay the necessary dividends, Clean Water would have to raise new equity to fund the difference. 
   
• Retained earnings: See above for the firm's payout policy.

With all this information at hand, the buyer now had to figure out whether Clean Water would be able to distribute the dividends he needed to service his own debt obligations.