Question 1 25 marks August Holdings Ltd and Sunday Ltd are considering a merger.
ID: 2657694 • Letter: Q
Question
Question 1 25 marks August Holdings Ltd and Sunday Ltd are considering a merger. Sunday Ltd is a listed company with total assets amounting to N$135 million. Its debt ratio is 25% and cost 9%. August Ltd has estimated that the free cash flow will be as follows:
Year FCF
$m
1 13
2 15
3 17.5
4 20
From year 5 and beyond free cash flows will grow at 6 percent indefinitely. These cash flows include all acquisition effects. The cost of equity for August Ltd is 14% since it has higher debt.
Required:
(a) What discount rate should be used to discount the estimated cash flows?4 marks
(b) What is the dollar value of Sunday Ltd? 6 marks
(c) How much is August Ltd prepared to pay for Sunday Ltd? 6 marks
(d) Explain the meaning of the following terms:
(i) Synergy
(ii) Divestiture
(iii) Leveraged buyout 9 marks
Explanation / Answer
a) The discount rate to be used to discount the estimated cash flows is 14% , because the August ltd is planning to acquire the Sunday ltd, it will discount the estimated cash flows by its own cost of capital.
b) Dollar value of Sunday ltd
Total value = 176.33
c)August ltd prepared to pay for sunday ltd = $176.33 million - (135×25%) = 176.33 - 33.75 = $142.58 millions
d) i) Synergy : The combined power of the two or more companies merge together is called synergy. Synergy is defined sometimes as when two or more companies work together will have a greater effect than to that of their individual work when they work on their own.
ii) Divestiture :The divestiture means the sale or disposition of certain company’s assets or a business unit which is not performing well and is disposed of either through closure, sale or bankruptcy.
iii) Leveraged buyout : A leveraged buyout is the purchase of a company using a large amount of borrowed funds to purchase another company. The purchasing company uses the assets of the company to be purchased as a collateral to get the loan for the purchase of the company .
Year cash flows($ in millions) Disc factor@14% Discounted cash flows($ in millions) 1 13 0.877 11.40 2 15 0.769 11.53 3 17.5 0.675 11.81 4 20 0.592 11.84 5 250 0.519 129.75Related Questions
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