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Question 3a

Staple Group is one of Barland’s biggest media groups. It consists of four divisions, organised as follows:

Staple National – the national newspaper, the Daily Staple. This division’s revenues and operating profits have decreased for the last two years.

Staple Local – a portfolio of 18 local and regional newspapers. This division’s operating profits have fallen for the last five years and operating profits and cash flows are forecast to be negative in the next financial year. Other newspaper groups with local titles have also reported significant falls in profitability recently.

Staple View – a package of digital channels showing sporting events and programmes for a family audience. Staple Group’s board has been pleased with this division’s recent performance, but it believes that the division will only be able to sustain a growth rate of 4% in operating profits and cash flows unless it can buy the rights to show more major sporting events. Over the last year, Staple View’s biggest competitor in this sector has acquired two smaller digital broadcasters.

Staple Investor – established from a business which was acquired three years ago, this division offers services for investors including research, publications, training events and conferences. The division gained a number of new clients over the last year and has thus shown good growth in revenues and operating profits.

Some of Staple Group’s institutional investors have expressed concern about the fall in profitability of the two newspaper divisions.

The following summarised data relates to the group’s last accounting year. The % changes in pre-tax profits and revenues are changes in the most recent figures compared with the previous year.

Division
Total National Local View Investor
Revenues ($m) 1,371·7 602·4 151·7 496·5 121·1
Increase/(decrease) in revenues (%) (5·1) (14·7) 8·2 16·5
Pre-tax profits ($m) 177·3 75·6 4·5 73·3 23·9
Increase/(decrease) in pre-tax profits (%) (4·1) (12·6) 7·4 19·1
Post-tax cash flows ($m) 120·2 50·7 0·3 53·5 15·7
Share of group net assets ($m) 635·8 267·0 66·6 251·2 51·0
Share of group long-term liabilities ($m) 230·9 104·4 23·1 93·4 10·0

Staple Group’s board regards the Daily Staple as a central element of the group’s future. The directors are currently considering a number of investment plans, including the development of digital platforms for the Daily Staple.

The finance director has costed the investment programme at $150 million. The board would prefer to fund the investment programme by disposing parts or all of one of the other divisions. The following information is available to help assess the value of each division:

– One of Staple Group’s competitors, Postway Co, has contacted Staple Group’s directors asking if they would be interested in selling 15 of the local and regional newspapers for $60 million. Staple Group’s finance director believes this offer is low and wishes to use the net assets valuation method to evaluate a minimum price for the Staple Local division.

– Staple Group’s finance director believes that a valuation using free cash flows would provide a fair estimate of the value of the Staple View division.

Over the last year, investment in additional non-current assets for the Staple View division has been $12·5 million and the incremental working capital investment has been $6·2 million.

These investment levels will have to increase at 4% annually in order to support the expected sustainable increases in operating profit and cash flow.

– Staple Group’s finance director believes that the valuation of the Staple Investor division needs to reflect the potential it derives from the expertise and experience of its staff.

The finance director has calculated a value of $118·5 million for this division, based on the earnings made last year but also allowing for the additional earnings which he believes that the expert staff in the division will be able to generate in future years.

Assume a risk-adjusted, all-equity financed, cost of capital of 12% and a tax rate of 30%. Goodwill should be ignored in any calculations.

Staple Group’s finance and human resources directors are looking at the staffing of the two newspaper divisions. The finance director proposes dismissing most staff who have worked for the group for less than two years, two years’ employment being when staff would be entitled to enhanced statutory employment protection.

The finance director also proposes a redundancy programme for longer-serving staff, selecting for redundancy employees who have complained particularly strongly about recent changes in working conditions.

There is a commitment in Staple Group’s annual report to treat employees fairly, communicate with them regularly and enhance employees’ performance by structured development.

Required:
(a) Evaluate the options for disposing of parts of Staple Group, using the financial information to assess possible disposal prices. The evaluation should include a discussion of the benefits and drawbacks to Staple Group from disposing of parts of the Staple Group. (19 marks)