Gekko Properties is considering purchasing Teldar Properties. Gekko\'s analysts

Question

Gekko Properties is considering purchasing Teldar Properties. Gekko's analysts project that the merger will result in incremental after-tax cash flows of $2 million, $4 million, $5 million, and $10 million over the next four years. The horizon value of the firm's operations, as of Year 4, is expected to be $107 million. Assume all cash flows occur at the end of the year. The acquisition would be made immediately, if it is undertaken. Teldar's post-merger beta is estimated to be 2.0, and its post-merger tax rate would be 35%. The risk-free rate is 6%, and the market risk premium is 5.5%. What is the value of Teldar to Gekko Properties?

$66,680,846

$70,190,364

$73,699,883

$77,384,877

$81,254,121

Explanation / Answer

Required return (CAPM) = Rf+×Rp

Rf is risk free return

Rp is risk premium

= 6%+2×5.5%

= 17%

PVF@17% Present value 1 $       2,000,000 0.855 $      1,709,402 2 $       4,000,000 0.731 $      2,922,054 3 $       5,000,000 0.624 $      3,121,853 4 $    10,000,000 0.534 $      5,336,500 Firm value at year 4 $ 107,000,000 0.534 $   57,100,555 Firm value $   70,190,364

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