Consider the following acquisition data regarding Washington Company and Orators Telecom Inc.:
Washington Company is considering an acquisition of Orators Telecom Inc. Washington Company estimates that acquiring Orators will result in incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company.
Data Collected (in millions of Dollars)
Year 1 Year 2 Year 3 EBIT 12.0 14.4 18.0 Interest Expense 3.0 3.3 3.6 Debt 29.7 35.1 37.8 Total net operating capital 107.1 109.2 111.3
Orators is a publicly traded company, and its market-determined pre-merger beta is 1.00. You also have the following information about the company and the projected statements.
- Orators currently has a $16.00 million market value of equity and $10.40 million in debt.
- The risk-free rate is 5.5% with a 7.60% market risk premium, and the Capital Asset Pricing Model produces a pre-merger required rate of return on equity RsL of 13.10%.
- Orators's cost of debt is 7.50% at a tax rate of 35%.
- The projections assume that the company will have a post-horizon growth rate of 5.00%.
- Current total net operating capital is $104.0, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisition is $27 million.
- The firm has no nonoperating assets, such as marketable securities.
With the given information, use the free cash flow to equity (FCFE) approach to calculate the following values involved in the merger analysis:
1. FCFE horizon value: $139.07 million / $129.75 million / $129.11 million / $146.75 million
2. Value of FCFE: $111.95 million / $39.60 million / $109.17 million / $125.77 million
3. The estimated value of Orators's operations after the merger is more / less than the market value of Orators's equity. This means that the wealth of Orators's shareholders will increase / decrease if it merges with Washington rather than remaining as a stand-alone corporation.
Consider the following acquisition data regarding Washington Company and Orators Telecom Inc.:
Washington Company is considering an acquisition of Orators Telecom Inc. Washington Company estimates that acquiring Orators will result in incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company.
Data Collected (in millions of Dollars)
| Year 1 | Year 2 | Year 3 | |
| EBIT | 12.0 | 14.4 | 18.0 |
| Interest Expense | 3.0 | 3.3 | 3.6 |
| Debt | 29.7 | 35.1 | 37.8 |
| Total net operating capital | 107.1 | 109.2 | 111.3 |
Orators is a publicly traded company, and its market-determined pre-merger beta is 1.00. You also have the following information about the company and the projected statements.
- Orators currently has a $16.00 million market value of equity and $10.40 million in debt.
- The risk-free rate is 5.5% with a 7.60% market risk premium, and the Capital Asset Pricing Model produces a pre-merger required rate of return on equity RsL of 13.10%.
- Orators's cost of debt is 7.50% at a tax rate of 35%.
- The projections assume that the company will have a post-horizon growth rate of 5.00%.
- Current total net operating capital is $104.0, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisition is $27 million.
- The firm has no nonoperating assets, such as marketable securities.
With the given information, use the free cash flow to equity (FCFE) approach to calculate the following values involved in the merger analysis:
1. FCFE horizon value: $139.07 million / $129.75 million / $129.11 million / $146.75 million
2. Value of FCFE: $111.95 million / $39.60 million / $109.17 million / $125.77 million
3. The estimated value of Orators's operations after the merger is more / less than the market value of Orators's equity. This means that the wealth of Orators's shareholders will increase / decrease if it merges with Washington rather than remaining as a stand-alone corporation.
Related questions
BTR Warehousing, which is considering the acquiition of Galaxy Sun Corp., estimates that acquiring Galaxy Sun will result in an incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company:
Data collected (in millions of dollars)
| Year 1 | Year 2 | Year 3 | |
| EBIT | $14.0 | $16.8 | $21.0 |
| Interest Expense | 4.0 | 4.4 | 4.8 |
| Debt | 31.9 | 37.7 | 40.6 |
| Total net operating capital | 121.5 | 123.9 | 126.3 |
Galaxy Sun Corp. is a publicly traded company, and its market-determined pre-merger beta is 1.20. You also have the following information about the company and the projected statements:
a) Galaxy Sun currently has a $32.00 million market value of equity and $ 20.80 million in debt.
b) The risk-free rate is 4%, there is a 6.10% market risk premium, and the capital aset pricing model purchases a pre-merger required rate of return on equity of 11.32%.
c) Galaxy Sun's cost of debt is 6.00% at a tax rate of 35%.
d) The projections assume that the company will have a post-horizon growth rate of 5.00%.
e) Current total net operating capital is $118.0, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisitionis $29 million.
f) The firm does not have any nonoperating assets such as marketable securities.
Given this information, use the adjusted present value (APV) approach to calculate the following values involved in merger analysis:
1. Unlevered cost of equity: 8.10%/ 6.82% / 9.22% / 10.50%
2. Horizontal value of unlevered cash flows: $211.99 million / $279.92 million / $266.59 million / $132.70 million
3. Horizontal value of tax shield: $41.80 million / $39.81 million / $66.35 million / $38.32 million
4. Unlevered value of operations: $64.28 million / $233.62 million / $235.75 million / $228.61 million
5. Value of tax shield: $35.94 million / $74.66 million / $62.57 million / $39.65 million
6. Value of operations: $138.94 million / $271.69 million / $268.26 million / $296.19 million
7. Thus, the total value of Galaxy Sun's equity is $250.89 million / $214.95 million / $43.48 million / $275.39 million
8. Supposse BTR Warehousing plans to use more debt in the first few years of theacquisition of Galaxy Sun Corp. Assuming that using more debt will not lead to an increse in bankruptcy costs for BTR Warehousing, the interest tax shields and tha value of the tax shield in the analyssis, will decrease / increase, leading to a higher / lower value of operations of the acquired firm.
9. The APV approach is considered useful for valuing acquisition targets, because the method involves finding the values of the unlevered firm and the interest tax shield separately and then summing those values. Why is it difficult to value certain types of acquisitions using the corporate valuation model?
- The acquiring firm immediately retires the target firm's old debt. Thus, the acquisition deal consists of only new debt in its capital structure.
- The acquiring firm usually assumes the debt of the target firm. Thus, old debt with different coupon rates usually becomes a part of the aquisition deal.
TransWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Georgia Cable Company (GCC), a regional cable company. TransWorld's analysts project the following post-merger data for GCC (in thousand of dollars):
| 2015 | 2016 | 2017 | 2018 | |||||||
| Net Sales | $499 | $568 | $599 | $630 | ||||||
| Selling and administrative expense | 48 | 54 | 63 | 71 | ||||||
| Interest | 18 | 21 | 24 | 27 | ||||||
| Tax rate after merger | 40% | |||||||||
| Cost of goods sold as a percent of sales | 80% | |||||||||
| Beta after merger | 1.65 | |||||||||
| Risk-free rate | 10% | |||||||||
| Market risk premium | 3% | |||||||||
| Continuing growth rate of cash flow available to TransWorld | 7% | |||||||||
If the acquisition is made, it will occur on January 1, 2015. All cash flows shown in the income statements are assumed to occur at the end of the year. GCC currently has a capital structure of 40% debt, but Trans World would increase that to 50% if the acquisition were made. GCC, if independent, would pay taxes at 20%; but its income would be taxed at 40% if it were consolidated. GCC's current market-determined beta is 1.55, and its investment bankers think that its beta will rise to 1.65 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 80% of sales, but could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to TransWorld's shareholders. The risk-free rate is 10%, and the market risk premium is 3%. Do not round intermediate calculations.
What is the appropriate discount rate for valuing the acquisition?
% (to 2 decimals)
What is the continuing value?
$ thousand (to 1 decimal)
What is the value of GCC to TransWorld?
$ thousand (to 1 decimal)
