Mini Case #2: Capital Budgeting at Neuquén, Inc.
Assignment Overview
Neuquén, Inc., a publicly traded firm, is considering the acquisition of a private
company,, which specializes in restoring damaged artwork and vintage
photographs for high net worth individuals. Neuquén’s CEO and chairman of the board,
Willie Ray, described the motivation for the acquisition as follows: “We are running out
of profitable investment opportunities in our core vintage shoe restoration business, and
our shareholders expect us to continue to grow. Therefore, we must look to acquisitions
to expand into growing markets.”
Neuquén, Inc.’s common stock is currently trading at $50 per share, and the firm has
100,000 shares outstanding. The book value of the common stock is $20 per share.
However, as mentioned by Mr. Ray, sales had been slowing recently and the board was
concerned that soon the share price would also begin to flag as investors figured out
that the firm was running out of positive NPV investments. The firm has $2,000,000
market value of bonds trading at a yield to maturity of 6.2%.
You have been hired as a consultant to Neuquén to evaluate the proposed acquisition
of There is considerable dissension among senior management and the
board about whether the acquisition should be undertaken. Your job is to perform a
thorough analysis of the merits of the proposed acquisition and make a
recommendation to senior management.
After several meetings with Neuquén management and a review of Artforever’s financial
performance and industry structure, you gathered the data shown in Table 1 below.
Forecast Data for (in $’000)
2018 2019 2020 2021 2022

Sales Revenue
Investment in CapEx and NWC
Interest payments
1,000.0 1,250.0 1,875.0 2,100.0 3,750.0
122.4 currently has $1,475,000 (market value) in long-term debt, with a
coupon rate of 7%. Its cost of goods sold (COGS) is expected to be 42% of sales
revenues, and selling, general and administrative (SG&A) expenses are expected to be
15 percent of revenues. The depreciation numbers listed above are already included in
COGS percentage estimates. The firm’s corporate tax rate is 40% and its current cost of
borrowing is 6.2%.

Your research indicates that Artforever has a target debt to value ratio of 15%, based on
its assessment of the probability and costs of financial distress. You note that this is
different from the capital structure of Neuquén and wonder how this would factor into
your analysis.
Although is a rapidly growing company, your analysis of industry
structure suggests that competition in the art restoration market is likely to increase in
the next few years. Thus, you forecast that the perpetual growth rate for free cash flows
beyond 2022 will be a more modest 2.0% per year.
Your analysis of market data yielded the information in Table 2 below.
Market Data

Current yield to maturity on 30 year treasury bonds
Current yield to maturity on 3 month treasury bills
Most recent 1-year return on the S&P 500
Estimate of expected average return on the S&P 500 over the next 30 years

Your analysis of’s industry reveals that most of the firms in the industry,
like Artforever, are private firms. However, you find a close competitor,,
that is in the same line of business and is publicly traded. ArtToday has a long-term
target debt to equity ratio of 0.75, and has been historically quite close to that target.
Your analysis of ArtToday’s historical returns against the market returns yields an equity
beta of 1.5. ArtToday currently has 50,000 common shares outstanding trading at $12
per share. Assume that both companies face a similar tax rate.
Guidelines for Case Analysis
The following aids are permitted for this analysis: You may use internet sources,
books, all posted materials (including Discussion Board Q&A), and your notes.
other aids are unauthorized and their use constitutes a violation of academic
. This includes face-to-face or electronic correspondence concerning the
specific details of the case with any other person that is not a member of your assigned
group, whether or not they have current or past affiliation with Texas A&M University
Corpus Christi.
The case is due on the date indicated on the course schedule. Late papers may be
accepted with a reasonable excuse, but will be assessed a 20% grade reduction
Cases should be typed in 12-point font, double-spaced, with a minimum
of 1 inch margins.
The case report should be written according to the following format:
1. Introduction
2. Analysis
3. Conclusion

The introduction sets the stage for the work to follow and should consist of
short paragraph of the key problem(s) or issue(s) that your analysis addresses. The
analysis will constitute the bulk of the written presentation and will be a direct response
to the questions below. Use clear, concise, and complete sentences. Do not use bullet
points or numbered paragraphs. The conclusion should be a
short paragraph that
summarizes the key points of the analysis.
Your report should not exceed five pages of double-spaced text with 1 inch
margins at the sides, top, and bottom of the page.
This does not include exhibits of
your computations.
You may submit one Excel spreadsheet that contains all your
exhibits, clearly labeled, and appropriately referenced in the text of your report.
Your analysis of “Neuquén, Inc.” should include answers to the questions below. Do not
write the questions verbatim in your report.
Instead, write a brief introductory
statement that summarizes the question before you proceed with your analysis.
1. What discount rate is appropriate for finding the value of
Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show
detailed computations in your Excel spreadsheet labeled Exhibit 1.
2. What are the relevant cash flows for valuing Assume that your
valuation is performed at the end of 2017, and that the values shown in Table 1 are
end-of-year forecasts.
Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show
detailed computations in your Excel spreadsheet labeled Exhibit 2.
3. Based on your answers to questions (1) and (2) above, what is the maximum price that
Neuquén should pay to
equity shareholders for
Write a few paragraphs giving your answer and clearly explaining your reasoning and computations; show
detailed computations in your Excel spreadsheet labeled Exhibit 3.
4. Under what conditions might you consider recommending that management make a
higher offer than your recommended price in (3) above?
No computations are necessary, just a short discussion.
Your report is intended for the senior management of Neuquén, Inc., so be sure that
you write in a professional style that is easy to follow.