Could someone please help with this question by chance? VolWorld Comm Inc., a la
ID: 2757919 • Letter: C
Question
Could someone please help with this question by chance? VolWorld Comm Inc., a large telecomm company, is evaluating the possible acquisition of Bulldog Cable Company (BCC), a regional cable company. VolWorld's analysts project the following post merger data for BCC (in thousands of dollars, with a year end of December 31):
2013 2014 2015 2016 2017 2018
Net Sales $450 $518 $555 $600 $643
Selling & admin expense 45 53 60 68 73
Interest 40 45 47 52 54
Total net op capital $800 850 930 1005 1075 1150
Tax rate after merger 35%
Cost of goods sold as a % of sale 65%
BCC's pre merger beta 1.4
Risk-free rate 6% Market risk premium 4%
Terminal growth of FCF 7%
If the acquisition is made, it will occur on January 1, 2014. All cash flows shown in the income statements are assumed to occur at the end of the year. BCC currently has a capital structure of 40% debt, which costs 10%, but over the next 4 years VolWorld would increase that to 50%, and the target capital structure would be reached by the start of 2018. BCC, if independent, would pay taxes at 20%, but its income woul be taxed at 35% if it were consolidated. BCC's current market -determined beta is 1.4. The cost of goods sold is expected to be 65% of sales.
a. What is the unlevered cost of equity for BCC?
b. What are the free cash flows and interest tax shields for the first 5 years?
c. What is BCC's horizon value of interest tax shields and unlevered horizon value?
d. What is the value of BCC's equity to VolWorld's shareholders if BCC has $300,000 in debt outstanding?
Explanation / Answer
a Firstly we have to find Unlevered beta
Unlevered Beta= Levered Beta/1+(1-0.35)*Debt/Equity
=1.40/1+(0.65)*(0.40/0.60)
=1.40/1.43
0.98
Cost of Equity= RF Rate+Beta(Risk Premium)
=6%+0.98(45)
=9.92%
(b)
Free Cash Flow= EBIT(1-t)-Changes in Operating Capital
Year1= (157.5-45)*(0.65)-(850-800)
= 73.13-50
=23.13
Year -1 Interest Tax Shiedl= 40*.35
=$14
Year -2 Free Cash Flow= (181.30-53)*.65-(930-850)
=4
Interest Tax Shield= 45*0.35
=$15.75
Year-3 = (194.25-60)*0.65-(1005-930)
=87.26-75
=12.26
Tax Shield= 47*0.35
=16.45
Year-4
FCF= (210-68)*.65-(1075-1005)
=92.3-70
=$22.30
Tax Shield=52*0.35
=18.2
Year-5 FCF= (225.05-73)*0.65-(1150-1075)
=98.83-75
=23.83
Tax shield on interest= 54*.35
=18.90
Horizon Value of Intereste Tax Shield= 510.68 Million
Unlevered Horizon Value= 643.89 Million
d Value of Equity= $508.57 Million
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