Problem 22-05
Merger Analysis
Marston Marble Corporation is considering a merger with theConroy Concrete Company. Conroy is a publicly traded company, andits beta is 1.30. Conroy has been barely profitable, so it has paidan average of only 25% in taxes during the last several years. Inaddition, it uses little debt; its target ratio is just 30%, withthe cost of debt 8%.
If the acquisition were made, Marston would operate Conroy as aseparate, wholly owned subsidiary. Marston would pay taxes on aconsolidated basis, and the tax rate would therefore increase to35%. Marston also would increase the debt capitalization in theConroy subsidiary to wd = 40%, for a total of $18.15 million indebt by the end of Year 4, and pay 11.0% on the debt. Marston'sacquisition department estimates that Conroy, if acquired, wouldgenerate the following free cash flows and interest expenses (inmillions of dollars) in Years 1-5:
Year Free CashFlows InterestExpense 1 $1.30 $1.2 2 1.50 1.7 3 1.75 2.8 4 2.00 2.1 5 2.12 ?
In Year 5, Conroy's interest expense would be based on itsbeginning-of-year (that is, the end-of-Year-4) debt, and insubsequent years both interest expense and free cash flows areprojected to grow at a rate of 8%.
These cash flows include all acquisition effects. Marston's costof equity is 8.2%, its beta is 1.2, and its cost of debt is 8.0%.The risk-free rate is 4%, and the market risk premium is 3.5%. Usethe compressed APV model to answer the following questions.
What is the value of Conroy's unlevered operations? Do not roundintermediate calculations. Enter your answer in millions. Forexample, an answer of $1.2 million should be entered as 1.2, not1,200,000. Round your answer to two decimal places.
$ million
What is the value of Conroy's tax shields under the proposed mergerand financing arrangements? Do not round intermediate calculations.Enter your answer in millions. For example, an answer of $1.2million should be entered as 1.2, not 1,200,000. Round your answerto two decimal places. Do not round intermediatecalculations.
$ million
What is the dollar value of Conroy's operations? Enter youranswer in millions. For example, an answer of $1.2 million shouldbe entered as 1.2, not 1,200,000. Round your answer to two decimalplaces.
$ million
If Conroy has $8 million in debt outstanding, how much wouldMarston be willing to pay for Conroy? Enter your answer inmillions. For example, an answer of $1.2 million should be enteredas 1.2, not 1,200,000. Round your answer to two decimal places. Donot round intermediate calculations.
$ million
Problem 22-05
Merger Analysis
Marston Marble Corporation is considering a merger with theConroy Concrete Company. Conroy is a publicly traded company, andits beta is 1.30. Conroy has been barely profitable, so it has paidan average of only 25% in taxes during the last several years. Inaddition, it uses little debt; its target ratio is just 30%, withthe cost of debt 8%.
If the acquisition were made, Marston would operate Conroy as aseparate, wholly owned subsidiary. Marston would pay taxes on aconsolidated basis, and the tax rate would therefore increase to35%. Marston also would increase the debt capitalization in theConroy subsidiary to wd = 40%, for a total of $18.15 million indebt by the end of Year 4, and pay 11.0% on the debt. Marston'sacquisition department estimates that Conroy, if acquired, wouldgenerate the following free cash flows and interest expenses (inmillions of dollars) in Years 1-5:
| Year | Free CashFlows | InterestExpense |
| 1 | $1.30 | $1.2 |
| 2 | 1.50 | 1.7 |
| 3 | 1.75 | 2.8 |
| 4 | 2.00 | 2.1 |
| 5 | 2.12 | ? |
In Year 5, Conroy's interest expense would be based on itsbeginning-of-year (that is, the end-of-Year-4) debt, and insubsequent years both interest expense and free cash flows areprojected to grow at a rate of 8%.
These cash flows include all acquisition effects. Marston's costof equity is 8.2%, its beta is 1.2, and its cost of debt is 8.0%.The risk-free rate is 4%, and the market risk premium is 3.5%. Usethe compressed APV model to answer the following questions.
What is the value of Conroy's unlevered operations? Do not roundintermediate calculations. Enter your answer in millions. Forexample, an answer of $1.2 million should be entered as 1.2, not1,200,000. Round your answer to two decimal places.
$ million
What is the value of Conroy's tax shields under the proposed mergerand financing arrangements? Do not round intermediate calculations.Enter your answer in millions. For example, an answer of $1.2million should be entered as 1.2, not 1,200,000. Round your answerto two decimal places. Do not round intermediatecalculations.
$ million
What is the dollar value of Conroy's operations? Enter youranswer in millions. For example, an answer of $1.2 million shouldbe entered as 1.2, not 1,200,000. Round your answer to two decimalplaces.
$ million
If Conroy has $8 million in debt outstanding, how much wouldMarston be willing to pay for Conroy? Enter your answer inmillions. For example, an answer of $1.2 million should be enteredas 1.2, not 1,200,000. Round your answer to two decimal places. Donot round intermediate calculations.
$ million
