M&A. For this and the next 3 questions: Teddy Corp is considering acquiring Dani
ID: 2755613 • Letter: M
Question
M&A. For this and the next 3 questions: Teddy Corp is considering acquiring Daniels Company. Daniels has a capital structure consisting of $5 million (market value) in 11% bonds and $10 million (market value) of common stock. Currently, Daniels has a beta of 1.36. Teddy's beta is 1.02. Both firms have tax a rate of 40%. Teddy's debt ratio is 40%. The free cash flows estimated for Daniels are $3 million for each of the next 4 years and a horizon value of $10 million in Year 4. Interest tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. Additionally, new debt would be issued to finance the acquisition. The new debt would have an interest rate of 8%. Currently, the risk-free rate is 6% and the market risk premium is 4%. Calculate the current WACC for the Daniels Company.
Calculate the value of the target firm's equity? There are no non-operating assets to consider. $17.11m $17.19 m $17.92m $22.11m $22.92m None of the above
Explanation / Answer
Cost of Equity = Risk free rate + [Market Risk Premium x Beta]
= 6 + [4 x 1.36]
= 11.44%
Cost of debt = 11 x [1-0.4]
= 6.6%
WACC for Daniels Company = [Cost of equity x Weight of Equity] + [Cost of Debt x weight of debt]
= [11.44 x 10 / 15] + [6.6 x 5 / 15]
= 9.83%
Value of Daniel's Equity = Present Value of future Cash flows at 9.83% discount rate
= 3 x [3.182] + 7 x [0.687] + 1 x [3.182] + 4 x [0.687]
= $20.29 million
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