(Cash for Stock Merger) This problem requires that you integrate the material le
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Question
(Cash for Stock Merger) This problem requires that you integrate the material learned in prior chapters. You have been given the job of evaluating the following merger candidate. You have collected the following cash flow estimates for the acquisition candidate for the proposed merger (in millions):
300
Market risk premium
Pre tax cost of debt
What is the after tax cost of debt for this merger (as we did in chapter 16)?
What is the after tax cost of common equity for this merger (as we did in chapter 16)?
What is the weighted average cost of capital for this acquisition candidate (as we did in chapter 16)?
Please run a net present value using the WACC calculated above with the total cash flows from the target (given above) to determine the maximum price per share you are willing to pay for this target candidate?
Based what you calculated and the current market price, would you pursue this candidate?
Year 1 2 3 4 5 Cash flows now for target 60 80 100 125 150 Additional cash flows(Synergy) 40 70 100 125 150 Total cash flows (after merger) 100 150 200 250300
Explanation / Answer
1. After tax cost of debt = Cost of debt (1 - Tax rate)
=8% (1-25%)
=6%
2. Cost of common equity = Rf + (Rm-Rf)
=4%+1.47(5%)
=11.35%
3. Weighted average cost of capital = (Cost of equity*Weight)+ (Cost of debt*Weight)
=(11.35%*0.60) + (6%*0.40)
= 9.21%
4. Calculation of net present value and maximum price that can be paid
YEAR
CASH FLOWS (millions)
PVF @ 9.21
PV of Cash flows (millions)
1
100
0.9157
91.57
2
150
0.8384
125.76
3
200
0.7677
153.54
4
250
0.7030
175.75
5
300
0.6437
193.11
Total
739.73
Maximum price that can be paid =793.73 millions /10 millions shares
=79.37 per share
Current market price of share is $51 which is less than what we can offer, so it is better to pursue this candidate
YEAR
CASH FLOWS (millions)
PVF @ 9.21
PV of Cash flows (millions)
1
100
0.9157
91.57
2
150
0.8384
125.76
3
200
0.7677
153.54
4
250
0.7030
175.75
5
300
0.6437
193.11
Total
739.73
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