Burton Sensors, Inc. is a small designer and manufacturer of temperature sensor.

It has
various products from standard and customized sensors, resistance temperature detectors,
temperature transmitters, and bearing temperature probes. It has a wide coverage of users
with in different industries from oil and gas, automotive, food to aerospace. The company
was initially financed with internal cash flows, however, in order to meet its rapid growth and
being competitive, the company starts to go IPO in year 2011 and issuing equity as well as
generating capital from banks. Sensor industry in the United States is a very competitive
market and there are numerous sensor suppliers. To gain competitive advantages, it is
necessary for companies such as Burton Sensors to initiate a close relationship with its
customers and offer them customized products based on customer needs. Customer-oriented
strategy leads to high inventory costs for sensor companies, as well as high research and
development costs.

Section I. High-growth strategy of Marshall, company financing and its potential stock
price change

It is necessary for Marshall continue to pursue a high-growth strategy due to the

competitiveness in the sensors industry in the United States. Taking year 2017 for instance,
there are more than 4,000 sensor OEMs in the country, and large companies have better
distribution channels and various products lines to meet different customer needs. For smaller
companies such as Burton, it is important for them to initial a solid customer relationship and
expand its networks to grow sales. There are four main publicly traded sensor manufacturers
in the US, TE Connectivity (TEL), Ametek (AME), Opsens (OPS) and Cyberoptics (CYBE).
In year 2016, these four companies have net sales of $13,113 million, $4,300 million, $17.75
million and $53.33 million, respectively. Their net incomes are $1,683 million, $681.47
million, -$6.54 million and $2 million, respectively. The net sales and net income of Burton
in year 2016 are $9.3 million and $0.35 million, much smaller compared to four largest
sensor producers (Table 1 and Table 2). Among these sensor manufacturers, OPS and Burton
has relatively stable growth in net sales, in year 2015 and 2016, where the growth rates of
OPS are 84% and 85%, while the growth rates of Burton are 23% and 19%, respectively
(Figure 1).
There are different ways of financing Burton Sensor for its further development, including
internally generated cash flows or retained earnings, debts, and equity. However, the
currently, the company has outstanding bank loans, counting 96% of the total value of
company receivables and inventory, far beyond the industry average, and banks are requiring
additional restrictions for its future loans. Moreover, Marshall has set the target leverage ratio
of debt to equity of 1. Hence, reasonable financing tools to maintain the high-growth strategy
of Burton should be retained earnings and equity. Nevertheless, the most of shares are held
by Marshall, her family and employees, meaning it is difficult for the company to raise equity
capital via stock issuance in the OTC market. This leads the best option for Marshall to
accept the deal by a private investor, issuing 450,000 common shares with a 73.7% discount
of its share price, at $3.5 per share, compared to the current market share price of $4.75. The
private placement will have a potential impact of decreasing Burton’s share price to $4,43 per
share after the new share issuing (Table 4).

Section II. Strategy of purchasing the thermowell machines

In order to evaluating whether Marshall should purchase the new thermowell machines, it is
necessary to calculate the NPV of the project (Table 3). A positive NPV indicates that the
return of the investment is higher than the cost and the project is profitable in general.

As it is mentioned in the case, it is hard to calculate the equity beta for Burton Sensors. By
looking at the comparative data for four publicly traded sensor manufacturers, i.e. the beta,
debt, equity of TEL, AME, OPS and CYBE. respectively. Taking the data of these four
comparative companies into account. In addition, as is mentioned by Marshall in the case, she
has her own target leverage ratio and want to have the ratio of total interest-bearing debt to
the book value of equity at approximately 1:1. Hence, in the case of lacking market data on
the stock prices of Burton, it is necessary to estimate its beta according to the data of four
comparative publicly traded sensor manufacturers. The average weighted equity beta is
approximately 1.5 (Table 3).

Return of equity r e =r f + Beta∗¿= 3% + 1.5*5.8%= 11.86%

Hence, Weighted average cost of capital

 E D
WACC=r e +r ( 1−τ ) = 11.86%*0.5+4.8%*(1-35%)*0.5=7.49%
V d V

The total cost of four new thermowell machines are $600,000 and machines have an
economic life of 7 years. There are also costs for hiring two operators with a total annual cost
of $170,000. Additional costs for materials and warehouse rents are $780,000 annually. Also,
the average net working capital will increase by $650,000. Moreover, lacking of the new
thermowell machines, the current equipment allowed to fulfill only half of Burton’s
production and the company had to spent $1.4 million to purchase thermowells. In
purchasing the thermowell machines, the company would save $1400000 in year 2016.

Considering the immediate cash inflow and inventory increase, using t=6 to calculate cash
inflow in 7 years, using the discount rate equals WACC = 7.49%, NPV = 41465 > 0.
Therefore, the company should purchase the new thermowell machines since the project NPV
is larger than 0.

Section III. Raising Capital by Issuing New Common Stock by Private Placement

In order to raise additional equity capital to support its projected sales growth and being
competitive in R&D for new product development, Marshall shall consider raising capital by
issue new common stocks. However, Currently, the stock of Burton is traded OTC, and
almost all shares are hold by Marshall, her family, and employees and other retail investors,
which means it is unlikely for Burton to raise capital via stock issuance OTC. In order to
facilitate the growth of the company, accepting the offer by a private investor, 450,000 shares
at $3.5 per share would be the only option (Table 4).

Taking the average stock price of $4.75, the private placement deal asks Marshall to issue
stocks at 73.7% discount of the market price, $3.5 per share. According to the income
statement of Burton, the number of common shares is 1,500,000, the total market
capitalization of Burton Sensors is 4.75*1500000=7.125 million, after the issue of 450,000
common shares to the private investor and additional 50,000 shares to the consulting firm that
broker the deal, the total number of common shares is 2,000,000, with a market capitalization
of $8.875 million. The new share price would be 8.875/2= $4.4375 (Table 4).

Therefore, the issue of new common stocks will increase the total common share numbers in
the balance sheet to be 2 million. The total market capitalization will be $8.875 million. The
existing shareholders will face a dilution of their shares. The new share price will be $4.4375.

The issue of new shares will reduce the existing shareholder’s ownership in the company.
After the issue of 450,000 common shares to the private investor and additional 50,000 shares
to the consulting firm, there are in total 2,000,000 shares, while the newly issued share
accounts 25% of the total shares, meaning the new private investor will have 22.5% control
of the company. This may add the difficulties in the future company governance and
management. Moreover, employees might not be happy as their share value decreases.

Section IV. Evaluation of the acquisition deal of Electro-Engineering, Inc.

There are two important factors in considering whether Marshall shall acquire Electro-
Engineering, Inc. First, the business of EE should be taken into account together with
Burton’s business. Whether there is a synergistic effect after the acquisition. Second,
financially, fair value of the acquisition deal should be calculated to see if it has a positive
NPV.

From the products and business operation perspective, EE focuses on fiber-optic sensors and
has a unique technology to construct probes from low-cost materials, making its sensors
cheaper and maintain longer utilization period. Currently, Burton has no business in the fiber-
optic sensor segment and acquiring EE should help it expanding into this new segment and
diversify its existing product line as well as broaden its customer base, hence to reduce
market risks. In addition, Marshall thinks that the distribution network of Burton will help
improve the current operation effectiveness of EE and help it gain more profit.

Financially, according to data in the case, the SG&A expenses will decrease from 26.54% to
23.86%, the sales growth is 24%, 17.5%,15%, 12% and 10% in year 2017, 2018, 2019, 2020
respective, COGS will decrease from 51% to 49%, and accounts payable increases to 4.5% of
sales in year 2017 and maintain the same level until year 2021. Projected income statement
and balance sheet have been attached with assumptions in table 5. The R&D expense of the
company from year 2017 to year 2021 remains at the same level of year 2016, 5.4%, and the
depreciation and amortization level remains the same at 5.06% in 5 years. The forecast driver
of inventory is cost of goods sold, with the forecast ratio of 23.05% in the forecasted 5 years.

In calculating the working capital, it is assumed that the working capital is non-cash working
capital and it is calculated as : Working Capital = Accounts Receivable – Accounts Payable +
Inventory. In addition, the capital expenditure included in calculating the free-cash-flow is
formulated as: Capital Expenditure = Net PP&E (current year) – Net PP&E (prior year) +
Depreciation and Amortization. Additionally, the capital expenditure from year 2017 to year
2021 is assumed in a rolling base. WACC is used as the discount rate to calculate the
enterprise value of the company. The EV of EE is $3,772,000 and its fair value is $3,544,000,
meanings its NPV is positive, and Marshall shall acquire EE (table 5).

Both business analysis and financial analysis indicate that Marshall should acquire Electro-
Engineering, Inc. in order to improve and diversify its products, broaden its customer-base,
and achieve a synergistic effect.

Even if the NPV of the acquisition is zero, Marshall should still proceed the deal. A zero
NPV means that the investment or the acquisition earns a rate of return equal to the discount
rate. There are business strategies other than pure financial consideration should been taken
into account. For instance, Marshall has a broaden strategy to enter into a new segment and
diversify products. Moreover, zero NPV might change, as WACC calculated is the status quo
of the company and there are assumptions as well, indicating that the calculated NPV might
not be the same as the actual NPV in practice. Therefore, even if the NPV equals zero, the
deal should still be proceeded.

Section V. Whether the acquisition allow EE to gain enough funding to invest in the
purchase of thermowell machines

Yes, the acquisition allows EE to gain enough funding to invest in the purchase of
thermowell machines. According to the deal proposed by the owner of EE, he is willing to
sell all equity for 10x of the company’s 2016 earnings before interest, taxes, depreciation, and
amortization (EBITDA). The EBITDA of year 2016 equals $686,600, and 10 times equal
$6.866 million, which is the acquisition price of EE. There are in total 1.1 million number of
common shares of EE, hence, the share price of EE is $6.866/1.1=$6.24, higher than the
Burton’s common share price, $4.75. EE gains $6,866,000 from the acquisition more than the
cost of purchasing thermowell machines of $600,000, with additional personnel costs of
$170,000 annually, and costs of additional materials and warehouse space $780,000 annually.

Appendix

Net Sales 2014 2015 2016

($Million)
TEL 12,233.00 12,238.0 13,113.00
0
AME 3,974.30 3,840.09 4,300.17
OPS 5.21 9.6 17.75
CYBE 41.13 66.24 53.33
Burton 6.34 7.79 9.3
Table 1 Net sales of publicly traded sensor manufacturers from year 2014 to year 2016

Net 2014 2015 2016

Income
($Million)
TEL 2,420.00 2,009.00 1,683.00
AME 590.86 512.16 681.47
OPS -2.88 -9.28 -6.54
CYBE -2.1 11.56 2
Burton 0.24 0.26 0.35
Table 2 Net income of publicly traded sensor manufacturers from year 2014 to year 2016
 100%

80%

60%

40%

20%

0%
2015 2016

-20%

Figure 1 Growth rate of net sales of publicly traded sensor manufacturers from year 2014 to
year 2016

Beta D E D/E tax Unleveraged

rate Beta
TEL 1.24 4344 9751 0.4455 35% 0.9616
AME 1.25 1866 4027.63 0.4633 35% 0.9607
OPS 1.02 5.3 17.97 0.2949 35% 0.8559
CYBE 0.85 - 52.28 35% -
Average 0.9261
Beta 1.52799191 1 35%
(Burton) 3

risk-free Equity Beta

premium
3% 5.80% 1.52799
2
Return of 11.86%
equity

Return of 4.80%
debt
WACC 7.49%

Cost of 600000
Machine
Economic 7 years (Taking
life of t=6)
machine
 payment to 170000
operators
costs for 780000
additional
materials
and
warehouse
Increase in 650000
working
capital
Net Cash -300000
flow
Saving cost 1400000
(spending
on
purchasing)

NPV 41465.77
Table 3 Calculation of purchasing the thermowell machines

Before share issue After share issue

Share outstanding 1500000 2000000
Initial Share Price 4.75
Price of issued 3.5
shares
Market 7125000 8875000
Capitalization
Increase in 1750000
Marketcap
Share price 4.4375

Table 4 Calculation of issuing New Common Stock

reduce its selling, general, and administrative (SG&A) expenses from 26.54% to
23.86% annually
grow its sales by 24% in 2017, 17.5% in 2018, 15% in 2019, 12% in
2020, and 10% in 2021
reduce its costs of goods sold
from 51% to 49%
accounts payable would increase to 4.5% of sales and remain
at that level

100% equity holdings for 10 times 2016 earnings before interest, taxes,
depreciation, and amortization
valued at $4.75 a share.

Income Projected
Statement
（$000s) 2014 2015 2016 2017 2018 2019 2020 2021
Sales 2944.9 3566.3 4,072. 5050.1 5933.9 6824.0 7642.8 8407.1
70 48 24 12 94 83
COGS (%) 51% 49% 49% 49% 49% 49%
COGS 1,525.00 1,811.70 2085. 2474.5 2907.6 3343.7 3745.0 4119.5
2 73 23 66 18 2
Gross 1,987. 2,575. 3,026. 3,480. 3,897. 4,287.
profit 50 58 30 25 88 66

SG&A 26.54 23.86 23.86 23.86 23.86 23.86

expense % % % % % %
(%)
SG&A 1080. 1204.9 1415.8 1628.2 1823.5 2005.9
expense 9 65 34 09 95 54
R&D 5.20% 5.00% 5.40% 5.40% 5.40% 5.40% 5.40% 5.40%
expense
(%)
R&D 153.1 178.3 219.9 272.67 320.39 368.45 412.66 453.93
expense 6 43 34 79 46
Depreciatio 4.83% 5.52% 5.06% 5.06% 5.06% 5.06% 5.06% 5.06%
n and
amortizatio
n (%)
Depreciatio 142.2 196.9 206.1 255.53 300.25 345.29 386.73 425.40
n and 75 65 5 04 35
amortizatio
n
Interest 18.7 18.7 18.7 18.7 18.7 18.7 18.7 18.7
expense
Pretax 461.9 823.70 971.12 1,119. 1,256. 1,383.
income 0 59 18 67
(loss)

Income 161.6 288.29 339.89 391.85 439.66 484.28

Tax (35%) 38 06 6 41 5
Net income 189.1 279.9 300.3 535.40 631.23 727.73 816.52 899.39
0

Balance Projected
Sheet
（$000s) 2014 2015 2016 2017 2018 2019 2020 2021
Accounts 485.9 592 680.1 848.42 1002.8 1160.0 1306.9 1446.0
Receivable 49 33 82 35 36
Accounts 16.50% 16.60% 16.70 16.80 16.90 17.00 17.10 17.20
Receivable % % % % % %
(%)
Inventory 279.8 413.7 480.6 570.34 670.15 770.67 863.15 949.47
32 32 62 73 31
Inventory 18.35% 22.83% 23.05 23.05 23.05 23.05 23.05 23.05
(%) % % % % % %
/COGS
Accounts 126.6 153.4 175.1 227.25 267.02 307.08 343.93 378.32
payable 67 66 06 02 33
Accounts 4.50% 4.50% 4.50% 4.50% 4.50%
payable %
(4.5% of
sales)
Working 639.1 852.3 985.6 1191.5 1405.9 1623.6 1826.1 2017.1
Capital 11 6 78 62 85
Change in -213.2 -133.3 - - - - -
working 205.91 214.44 217.71 202.48 191.02
capital 1 8 8 4 3
Note:
working capital calculation is supposed to be non-cash working capital,which is calculated
as AR - AP + Inventory

FCF Projected
（$000s) 2014 2015 2016 2017 2018 2019 2020 2021
Net income 189.1 279.9 300.3 535.40 631.22 727.73 816.51 899.38
28 55 25 9 64
Depreciatio 142.2 196.9 206.1 255.53 300.25 345.29 386.73 425.40
n and 75 65 5 04 35
amortizatio
n
Change in -213.2 -133.3 - - - - -
working 205.91 214.44 217.71 202.48 191.02
 capital 1 8 8 4 3
Capital 287.1 346.6 316.85 316.85 326.76 320.15 321.25
Expenditur 67 56 74
e
FCF 402.9 293.1 680.00 829.08 963.97 1085.5 1194.5
17 04 89 78 56
Note:
Capital Expenditure rolling
assumption

Valuation Projected
（$000s) 2014 2015 2016 2017 2018 2019 2020 2021
Time 1 2 3 4 5
FCF 293.1 680.00 829.08 963.97 1085.5 1194.5
17 04 89 78 56
WACC 7.49% 7.49% 7.49% 7.49% 7.49%
(discount
rate)
Discount 1.0749 1.1554 1.2419 1.3349 1.4349
Factor 1 5 72 62
Discounted 632.61 717.56 776.18 813.18 832.46
86 38 16 4 53

EV 3772.013
3
Net Debt 227.7
Fair Value 3544.313
3

EBITDA 686.6
10x 6866
Table 5 Evaluation of Acquisition deal of Electro-Engineering, Inc