Case Notes/Answers
sterling household product company, By William
Fruhan, Craig Stephenson
Discussion Questions:
The Sterling Household Products Company case has four primary learning objectives:
1. To illustrate a situation where one company is acquiring a products unit in a completely different
industry. In such a transaction, the risk and required rate of return for the target is different from that
of the acquirer; the acquirer’s existing cost of capital cannot be used to value the target, and students
should recognize this fact.
2. To present financial information for several firms in the health care industry, forcing students
to identify those companies which are true peers to the target products unit. Once these true peer
companies are identified, the asset beta coefficient of the target can be estimated, and combined with
the other information in the case, the appropriate risk-adjusted discount rate for the target can be
determined.
3. To provide students practice in calculating the expected free cash flow and terminal value from an
investment, given pro-forma income statement and balance sheet information.
4. To apply the appropriate risk-adjusted cost of capital for the target to its expected free cash flow,
and determine the value of the proposed acquisition to Sterling.
, 5-913-557
APRIL 30, 2013
TEACHING NOTE
WILLIAM E. FRUHAN
CRAIG STEPHENSON
Sterling Household Products Company
Note: The “Sterling Household Products” case has two additional supplements in Excel format,
both available free of charge from HBP.
Product 913558 is a Student Spreadsheet that Harvard Business Publishing makes widely available. It
contains the data-based exhibits in the case.
Product 913559 is restricted to Instructors Only. It contains data from the case and from this
Teaching Note, including the “model solution” to the basic quantitative assignment that students
are expected to complete as part of case analysis.
Critical Issues
Sterling Household Products Company is a comprehensive investment analysis case, requiring
students to consider a wide range of quantitative and qualitative issues when evaluating an
important strategic acquisition. Students must un-lever and then re-lever beta coefficients for the
investment project to determine its systematic risk, and then estimate the cost of equity and overall
cost of capital for this proposed investment which is unrelated to Sterling’s existing product lines.
The free cash flow for 10 years and the terminal value at year 10 from the investment must also be
forecasted, allowing students to determine the net present value of the cash flows from the
acquisition. The result of this NPV calculation is negative, so capital budgeting analysis of the base
investment shows that Sterling should not acquire the products unit at the tentatively negotiated
price of $265 million. The proposed acquisition, however, gives Sterling the opportunity to quickly
follow up with an investment expanding the capacity of the unit, and this follow-up investment has a
large and positive net present value. This NPV from the expansion, in fact, is so large that the total
combined NPV from the acquisition and follow-up expansion investment is significantly positive;
Sterling should acquire the products unit and implement the follow-up expansion investment.
sterling household product company, By William
Fruhan, Craig Stephenson
Discussion Questions:
The Sterling Household Products Company case has four primary learning objectives:
1. To illustrate a situation where one company is acquiring a products unit in a completely different
industry. In such a transaction, the risk and required rate of return for the target is different from that
of the acquirer; the acquirer’s existing cost of capital cannot be used to value the target, and students
should recognize this fact.
2. To present financial information for several firms in the health care industry, forcing students
to identify those companies which are true peers to the target products unit. Once these true peer
companies are identified, the asset beta coefficient of the target can be estimated, and combined with
the other information in the case, the appropriate risk-adjusted discount rate for the target can be
determined.
3. To provide students practice in calculating the expected free cash flow and terminal value from an
investment, given pro-forma income statement and balance sheet information.
4. To apply the appropriate risk-adjusted cost of capital for the target to its expected free cash flow,
and determine the value of the proposed acquisition to Sterling.
, 5-913-557
APRIL 30, 2013
TEACHING NOTE
WILLIAM E. FRUHAN
CRAIG STEPHENSON
Sterling Household Products Company
Note: The “Sterling Household Products” case has two additional supplements in Excel format,
both available free of charge from HBP.
Product 913558 is a Student Spreadsheet that Harvard Business Publishing makes widely available. It
contains the data-based exhibits in the case.
Product 913559 is restricted to Instructors Only. It contains data from the case and from this
Teaching Note, including the “model solution” to the basic quantitative assignment that students
are expected to complete as part of case analysis.
Critical Issues
Sterling Household Products Company is a comprehensive investment analysis case, requiring
students to consider a wide range of quantitative and qualitative issues when evaluating an
important strategic acquisition. Students must un-lever and then re-lever beta coefficients for the
investment project to determine its systematic risk, and then estimate the cost of equity and overall
cost of capital for this proposed investment which is unrelated to Sterling’s existing product lines.
The free cash flow for 10 years and the terminal value at year 10 from the investment must also be
forecasted, allowing students to determine the net present value of the cash flows from the
acquisition. The result of this NPV calculation is negative, so capital budgeting analysis of the base
investment shows that Sterling should not acquire the products unit at the tentatively negotiated
price of $265 million. The proposed acquisition, however, gives Sterling the opportunity to quickly
follow up with an investment expanding the capacity of the unit, and this follow-up investment has a
large and positive net present value. This NPV from the expansion, in fact, is so large that the total
combined NPV from the acquisition and follow-up expansion investment is significantly positive;
Sterling should acquire the products unit and implement the follow-up expansion investment.
