I require some help with my homework assignment in system engineering.
Each answer should be 1 page long using 12 pt font and 1.5 spacing.
Rosetta Stone: Pricing the 2009 IPO
Case Objectives
This case is about the IPO of Rosetta Stone, the language learning company. It demonstrates the challenge to investors of valuing a company that is not publicly traded and the investment bank's challenge in setting a fair offering price when it does not know investors' value estimates. It is also meant to (a) give you some simple practice in choosing comparable firms and key assumptions, (b) see the impact of growth and ratio assumptions on income and valuation, and (c) give you another chance to do an (A)PV analysis.
Your Challenge
Each group must arrive at their own private values of the shares offered and be prepared to bid for the shares in an offering to be conducted in class. Your spreadsheets with your private valuations must submitted via Moodle, as usual. The valuation you write up is what you think the shares are really worth, not what you think the offer price will be!
One group will act as the underwriter (investment bank). The details for the in-class offering are at the end of these instructions. First, I want to review what your write-up must cover.
Guidelines on the Valuation
Using discounted-cash-flow ("DCF") APV-based analysis, estimate the value of Rosetta Stone's shares. Your written analysis must include your spreadsheet calculations and explanations of your key assumptions. (Explanations can be submitted as part of your Excel spreadsheet or as a separate PDF or Word file.) Your cash flow analysis should use 10-year projections (plus terminal values, of course!). A projection example is given in Exhibit 8 of the case. All case exhibits are posted as an Excel spreadsheet on Moodle.
Steps in your analysis:
First off, read the case. Skip the discussion of the IPO process on pages 5-8; we will cover that material in class.
Below, I have listed the steps your analysis must cover.
1. Choose one or more comparable firms that you will use in your analysis. Uses for these firms include calculating an unlevered beta and return for Rosetta Stone and possibly gaining insight into growth rates, etc. Explain which firms you chose and why you chose them. (Short essay; 1 or 2 paragraphs.)
2. Next, forecast unlevered net income, net working capital balances, depreciation, and capital expenditures; use these to calculate unlevered cash flows. Use the forecast in Exhibit 8 as a starting point for your analysis. I strongly recommend that you copy that worksheet and use its structure as a template for much of your analysis. Further instructions on this follow:
a. First, project the four growth rates and ratios given in the top of Exhibit 8: (i) revenue growth rate, (ii) gross profit margin percentage, (iii) SG&A expense/revenue, and (iv) R&D expense/revenue. Explain the reasoning behind your choices. (Short essay.) Note that all 2008 numbers are actual. If you want to gauge your growth rates against inflation, assume expected inflation is 2.5% for the foreseeable future.
b. By contrast, take the projections for capital expenditures and PP&E balances in Exhibit 8 as fixed (i.e., you should not change these). Do the same for the projections of NWC turnover (that is, NWC/revenue).
These assumptions are imposed to simplify your analysis. 1
c. Using the worksheet template, you will find that these assumptions immediately give you forecasts for revenues, SG&A expense, R&D expense, EBIT, and net working capital balances. You will still need to calculate corporate income taxes to get unlevered net income (NOPAT); Rosetta Stone's tax rate is given on page 9 of the case.
d. To calculate unlevered cash flows, you will need forecasts of depreciation expense, which is part of SG&A. I have added this as a memo item at the bottom of Exhibit 8.
e. These steps will give you everything you need to calculate unlevered cash flows for Rosetta Stone. (You may want to consult Joyce's Juice or Rick Nelson's capital budgeting template as a refresher on this.)
Comment on Step 2a: the case includes analysts' views on what forecasts are reasonable, along with historical information for Rosetta Stone and revenue and income growth rates for comparable firms. You can use some or all of this in making your forecast assumptions, but do not spend a lot of time on this-2 hours tops!
3. To make life simple, assume that Rosetta Stone will retire all outstanding debt with IPO proceeds, and that it will have no debt going forward. This means interest tax shields will be zero.
4. Estimate the unlevered beta and unlevered return for Rosetta Stone, making use of the information in Exhibit 10 for the comparable firms you have chosen. Use all of the following assumptions:
a. Assume that comparable firms that have debt have βD = 0. (Their debt is "risk-free.")
b. For the risk-free rate, use the 30-year Treasury rate from Exhibit 4 in the case less an estimated term premium of 1.00%.
c. Disregard the case's estimates of the market risk premium; instead, assume that this premium is 6.00%.
In doing calculations for this step, it may be helpful to refer to the "Cost of Capital" section of the Joyce's Juice case.
5. Calculate the APV of Rosetta Stone using the cash flows calculated above. State and briefly explain your long-term growth assumptions for terminal value. (Short essay.) In doing the calculations for this step, you may want to refer to the "Business Valuation" section of the Joyce's Juice case
6. Estimate the value of the firm's shares, using the "premoney" valuation technique described in footnote 6 on page 10 of the case:
a. Ignore how any net cash raised from the IPO would affect firm value.
b. Using Rosetta Stone's APV as an estimate of firm value ("enterprise value", in the language of the case), calculate Rosetta Stone's equity value. (Here, you may want to refer to the in-class exercise in which we calculated the market-value balance sheet of Joyce's Juice.)
c. Finally, calculate share value by dividing equity value by the pre-IPO number of shares, which you can find in Exhibit 9.
Time permitting, we will discuss how to adjust for the dilutive effect of the IPO in class.
The Best Efforts Offering
The case has Rosetta Stone offering 6.25 million shares. We will assume that each group can purchase at most 1 million shares. In class, I will hand out and explain order forms for you to fill out after the underwriting group's presentation.
Determining the Fair Market Value. This is an attempt to approximate the price at which the shares will trade in the open market after the IPO is done. Your true valuations will be ordered from the highest to the lowest; the highest and lowest valuations will then be thrown out. The fair market value will be defined as the average of the valuations that remain.
The underwriter: one group will volunteer to serve as underwriter. They will select a single price at which to offer the 6.25 million shares. The group's presentation will focus on promoting the company at the offer price selected. This group's profit will be based on the proceeds raised in the issue (i.e., they get a percentage fee times the gross proceeds).
Rules of share purchases: all other groups will submit orders stating the number of shares they desire at the underwriting group's offer price. If there are orders for fewer than 6.25 million shares, the offer fails. If there are orders for more than 6.25 million shares, shares will be distributed on a pro rata basis.
Investor groups' profits from the auctions: to compute each group's profit, take the difference between the fair market value and the offer price and multiply it by the number of shares (if any) allocated to the group.
The underwriter group will receive a fee of 7% of gross proceeds. Gross proceeds = (offer price)(number of shares sold).
"Smart money" investors: in addition to the nine investor groups, a pool of smart money investors with special knowledge of the market's demand for this stock can buy up to 6.25 million shares at the offering price. These investors know the fair market value of the shares in advance, so they will only bid if the offer price is less than the fair market value.
(The smart money investors are just a market feature; no one in the class plays this role. I will say more about why this is a realistic feature of the market after we conduct the offering.)
Why Volunteer to be the Underwriting Group?
- Your group will get extra credit on class presentation and on their case grade, along with some free consulting from the SEC (me).
- Groups that presented the NCS case cannot serve as underwriter.
Attachment:- Rosetta Stone Case.rar