You are hired by Goldman Sharks (GS), a leading investment bank in the financial sector. Lucent Technologies is considering the purchase of Youx, a private firm in the electronics industry. Lucent has...

You are hired by Goldman Sharks (GS), a leading investment bank in the financial sector. Lucent Technologies is considering the purchase of Youx, a private firm in the electronics industry. Lucent has hired GS to evaluate the costs and benefits of the acquisition. As a preliminary step, your boss asks you to assess the value of Youx's assets as of year 2021. The current financial statements of Youx show that the firm is currently unlevered. The pro-forma statements of Youx for the incoming years contain the following information: The revenues of Youx are expected to be USD 80 million in 2022. The operating cost of Youx is expected to be 15% of its revenues in 2022. The operating margin of Youx will remain the same in the foreseeable future. Selling and general administrative expenses are expected to be 3% of Youx’s revenues in 2022. These costs are expected to remain the same in the foreseeable future. The capital expenditures of Youx are expected to be 25% of its revenues. Youx will reinvest the same fraction of its revenues as capital expenditures in the subsequent years. The depreciation amounts to 30% of capital expenditures every period. Youx will spend USD 0.5 million in Research and Development (R&D) in 2022. R&D expenses are expected to grow proportionately to sales. Youx has no net working capital (i.e. current assets minus current liabilities) in 2021. Going forward, Youx will require a net working capital of 2% of revenues to operate. You find three comparable firms quoting at the New York Stock Exchange (NYSE) operating in the same industry group as Youx. You have the following data on these firms: You know that all three comparable firms have investment grade credit ratings. The historical market risk premium is 6%. The current US treasury 20-year bond rate is 3%. The current US treasury 1-year bond rate is 2%. The CEO of Youx expects the cash-flows of the firm to grow at 5% in the foreseeable future. The marginal corporate tax rate is 34%. You engage in the valuation of Youx for the sake of writing a report to be delivered to Lucent Technologies. As a second step, your boss asks you to price a growth opportunity of Youx, which has not been accounted for in the pro-forma statements of the firm. In particular, Youx has the opportunity to launch a new product for solar temperature control called DTH. The initial capital expenditure required to launch DTH is $50 million. The operating margin of DTH is uncertain. Operating margin is defined as revenues per unit produced, net of operating costs per unit produced. Youx expects to sell 1 million units of DTH for 10 years, once DTH is launched. If Youx invests in DTH, there are two possible strategies: • The first possible strategy of Youx is to invest in DTH in 2023, to start receiving cash flows from the new product one year later (i.e. 2024), for 10 consecutive years. • The second possible strategy of Youx is to invest in DTH in 2024, to start receiving cash flows from the new product one year later (i.e. 2025), for 10 consecutive years. The operating margin of DTH is expected to be either be $40 or $5 per unit produced as of 2023. The expected operating margin of DTH in 2024 depends on the price at which a rival firm will introduce a competing product. If the competitors' price is low, the operating margin of DTH will be $5. If the competitor's price is high, the operating margin of DTH will be $40. Once the competitor of DTH starts selling their product in 2024, the operating margin will either stay at $40 or $5 for the remaining years. The free cash flows of DTH for any given year after launch equal operating margin times units sold. DTH’s revenues are not taxable due to green taxation laws. The Marketing Team of Youx has estimated that the physical (actual) probability that the operating margin of DTH goes to $40 in 2024 is 20%. This is because the marketing team reckons there is a 20% probability that the rival firm sells their new competing product at a higher price that year. The expected free cash-flows of DTH are as risky as the current projects of Youx. 4. Should Youx invest in DTH? If so, when? Which strategy should Youx follow? Explain your answer quantitatively and qualitatively. [15 points]