TransWorld Communications Inc., a large telecommunications company, is evaluatin

Question

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):

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 35% if it were consolidated. GCC's current market-determined beta is 1.4, and its investment bankers think that its beta will rise to 1.5 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 85% 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 8%, 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)

2015 2016 2017 2018 Net Sales $474 $547 $584 $628 Selling and administrative expense 42 48 56 65 Interest 18 21 24 27 Tax rate after merger 35% Cost of goods sold as a percent of sales 85% Beta after merger 1.50 Risk-free rate 8% Market risk premium 3% Continuing growth rate of cash flow available to TransWorld 5%

Explanation / Answer

Answer 1

Appropriate discount rate for valuing the acquisition => 8% + (3%) *1.5

=> 12.5%

Answer 2

Continuing Value => 1.30 + 5% / (12.5%-5%)

Continuing Value => $18.2

Answerr 4

The value of GCC to TransWorld's shareholders is the present value of the cash flows that accrue to the shareholders

=> 7/ (1.125) + 8/(1.125)2 + 5/(1.125)3 +19.50/(1.125)4

=> 6.22 + 6.32 + 3.51 +12.17

Value of GCC to TransWorld's shareholders=> $28.22

2015 2016 2017 2018 Sales 474 547 584 628 COGS 403 465 496 534 Gross Profit 71 82 88 94 Selling Exp 42 48 56 65 Interest 18 21 24 27 EBT 11 13 8 2 TAxes (35%) 4 5 3 0.7 EAT 7 8 5 1.30

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