TCA, a large conglomerate, is evaluating the possible acquisition of CHC, a tran
ID: 2779570 • Letter: T
Question
TCA, a large conglomerate, is evaluating the possible acquisition of CHC, a transistor manufacturer. TCA’s analysts project the following post-merger free cash flows (in millions of dollars):
2012
2013
2014
2015
Net Sales
$200.0
$230.0
$257.0
$269.8
Cost of Goods Sold
130.0
140.0
145.0
150.0
Selling/admin expenses
20.0
25.0
30.0
32.0
EBIT
$50.0
65.0
82.0
$87.8
Taxes on EBIT
20.0
26.0
32.8
35.1
NOPAT
30.0
39.0
49.2
52.7
Investment in net operating Capital
10.0
12.0
13.0
15.0
Free cash flow
20.0
27.0
36.2
37.7
Interest
10.0
14.0
16.0
21.3
The acquisition, if made, would occur on January 4, 2012. All cash flows above are assumed to occur at the end of the year. CHC currently has a market capital structure of 10 percent debt with $30 million of debt costing 8%. TCA would increase the debt to 50%, with an expected rate of 9.5% by the end of four years, if the acquisition were made. CHC, if independent, pays taxes at 30 percent, but its income would be taxed at 40 percent if consolidated. CHC’s current market-determined beta is 1.80.
The cash flows above detail the free cash flows and the interest on all of the debt associated with the acquisition, as well as the full taxes paid by TCA on the CHC income stream. The last year of projections are at CHC’s long-term capital structure. Required investment in net operating capital are also shown. TCA expects CHC’s free cash flows and tax shields to grow at 4% rate after the horizon. The risk-free rate is 6 percent and the market risk premium is 5 percent.
Use the compressed adjusted present value approach to answer the following questions
What is the horizon value of the tax shields?
PLEASE SHOW YOUR WORK AND THE STEPS YOU TOOK TO FIND THE SOLUTION)
2012
2013
2014
2015
Net Sales
$200.0
$230.0
$257.0
$269.8
Cost of Goods Sold
130.0
140.0
145.0
150.0
Selling/admin expenses
20.0
25.0
30.0
32.0
EBIT
$50.0
65.0
82.0
$87.8
Taxes on EBIT
20.0
26.0
32.8
35.1
NOPAT
30.0
39.0
49.2
52.7
Investment in net operating Capital
10.0
12.0
13.0
15.0
Free cash flow
20.0
27.0
36.2
37.7
Interest
10.0
14.0
16.0
21.3
Explanation / Answer
If there are no real or financial barriers to international capital and goods flows, FIs can eliminate all foreign exchange rate risk exposure. Sources of foreign exchange risk exposure include international differentials in real prices, cross-country differences in the real rate of interest (perhaps, as a result of differential rates of time preference), regulatory and government intervention and restrictions on capital movements, trade barriers, and tariffs.
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