Raymond Supply, a national hardware chain, is considering purchasing a smaller c
ID: 2753244 • Letter: R
Question
Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP). Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value, in millions, of SGP to Raymond?
Year 1 2 3 4 Free cash flow $1 $3 $3 $7 Unlevered horizon value 75 Tax shield 1 1 2 3 Horizon value of tax shield 30Explanation / Answer
Cost of Equity = Risk Free Rate + Beta * Market Risk Premium = 8% + 2 * 4% = 16%.
Weighted Average Cost of Capital
= Weight of debt * Cost of debt * (1 – Tax Rate) + Weight of Equity * Cost of Equity
= 0.30*10%*(1 - 0.34) + 0.70*16% = 13.18%.
The Cash Flows would be:
Total Value of operations of SGP = $79.64 million
Value of SGP to Raymond = Total Value of Operations - Value of Debt
= 79.64 - 15 = $64.64 million
Year Cash Flow Discounted Cash Flow 0 0 0.00 1 2 1.77 2 4 3.12 3 5 3.45 4 117 71.30 Total 79.64Related Questions
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