\'Wansley Portal Inc., a large Internet service provider, is evaluating the poss

Question

'Wansley Portal Inc., a large Internet service provider, is evaluating the possible acquisition of Alabama Connections Company (ACC), a regional Internet service provider. Wansley's analysts project the following post merger data for ACC (in thousands of dollars):

'If the acquisition is made, it will occur on January 1, 2016. All cash flows shown in the income statements are assumed to occur at the end of the year. ACC currently has a capital structure of 30 percent debt, which costs 9 percent, but Wansley would increase that to 40 percent debt, costing 10 percent if the acquisition were made. ACC, if independent, would pay taxes at 30 percent, but its income would be taxed at 35 percent if it were consolidated. ACC's current market-determined beta is 1.40. The cost of goods sold is expected to be 65 percent of sales, but it could vary somewhat. Gross investment in operating assets is expected to be equal to depreciation--replacing worn out equipment, so net investment in operating assets will be zero. The risk-free rate is 7 percent, and the market risk premium is 6.5 percent. Wansley currently has $400,000 in debt outstanding.

'b. What is the horizon value of the tax shields and the unlevered operations? What is the value of ACC’s operations and the value of ACC’s equity to Wansley’s shareholders?

Before we can proceed with this problem, we must generate pro forma income statements for ACC's operations after the proposed merger so we can calculate free cash flow and interest tax shields.

'* In this scenario, we state that investment in net operating capital is zero. This arises from the fact that the only needed investments are those needed to replace worn out capital, and that they equal depreciation.

'We must determine the tax shields.

'From this point, we can derive horizon value from the basic DCF framework.

'The tax shield is the interest multiplied by the post-merger tax rate.

Can someone check if this correct and show the formulas if it is incorrect in an excel sheet with their corresponding cell? Thank you

Explanation / Answer

I guess NOPAT is wrong in your case

NOPAT = EBIT - Taxes

You will have values of EBIT and Taxes from the above table

So, NOPAT should be

Calculation for HVUL(2020) would change then.

2016 2017 2018 2019 2020 EBIT 115 140 165 176 186.1 NOPAT 85.25 105 123 135.4 146.865 Investment in Net Operating Capital 0 0 0 0 0 FCF 85.25 105 123 135.4 146.865

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