ACCA · Question 01 · Advanced investment appraisal and M&A

SECTION A - STRATEGIC CASE STUDY

This question is worth 50 marks.

AeroVentis Co is a European-based multinational manufacturer of advanced composite blades for offshore wind turbines. The board of directors is seeking to expand its technological capabilities and is considering the acquisition of GaleTech Inc, a US-based startup specializing in AI-driven predictive maintenance software for wind farms. GaleTech is currently unlisted, but its founders are considering an IPO if a suitable trade sale is not achieved.

AeroVentis plans to acquire 100% of GaleTech's equity. The acquisition will be financed entirely by a new issue of €400 million in 8% loan notes by AeroVentis, which will significantly alter AeroVentis's capital structure.

Exhibit 1: GaleTech Inc Financial Projections (in $ millions)
Year 1: Operating Profit (EBIT) = $45m
Year 2: Operating Profit (EBIT) = $58m
Year 3: Operating Profit (EBIT) = $72m
Year 4: Operating Profit (EBIT) = $85m

After Year 4, free cash flows to the firm are expected to grow at a constant rate of 3% per annum in perpetuity.
Tax depreciation is equal to the annual capital investment needed to maintain operations. However, to achieve the projected growth, GaleTech will require an additional net working capital injection of $5m in Year 1 and $8m in Year 2.
GaleTech currently has $50m of 6% debt outstanding, which will be paid off immediately upon acquisition using part of the acquisition funds.

Exhibit 2: Market and Economic Data

• Current spot exchange rate: $1.15 / €1
• Expected inflation rates: US = 2.5% p.a., Eurozone = 1.8% p.a.
• AeroVentis's current cost of equity is 11%, and its after-tax cost of debt is 4.5%.
• The risk-free rate is 3% and the equity risk premium is 6%.
• GaleTech's asset beta is estimated to be 1.40.
• Corporate tax rate in both jurisdictions is 25%.

Exhibit 3: Synergies and Financing Costs
AeroVentis expects to generate post-tax operational synergies of €12 million per year, starting in Year 2 and continuing indefinitely.
The issue costs for the new €400 million loan notes will be 2% of the gross sum raised. These issue costs are not tax-deductible.

REQUIREMENTS:

Write a report to the Board of Directors of AeroVentis Co that covers the following:

(a) Estimate the base case present value of GaleTech Inc in Euros (€) using the Free Cash Flow to Firm (FCFF) method, discounting at an appropriate risk-adjusted rate. (14 marks)

(b) Calculate the Adjusted Present Value (APV) of the acquisition of GaleTech Inc, incorporating the financial side effects of the new debt issue and the expected synergies. Conclude on whether the acquisition is financially viable if the asking price is €380 million. (16 marks)

(c) Discuss the key assumptions and limitations inherent in your APV calculation, particularly focusing on the challenges of cross-border valuations and forecasting AI-tech startup cash flows. (10 marks)

(d) Advise the board on the strategic rationale for acquiring an AI software firm rather than developing the technology in-house, and discuss two defense tactics GaleTech's founders might employ if they view AeroVentis's bid as hostile. (6 marks)

Professional marks will be awarded for the format, structure, and clarity of the report. (4 marks)