(Cash for Stock Merger) This problem requires that you integrate the material le
ID: 2625128 • Letter: #
Question
(Cash for Stock Merger) This problem requires that you integrate the material learned in prior chapters. You have been given the job of evaluating the following merger candidate. You have collected the following cash flow estimates for the acquisition candidate for the proposed merger (in millions):
Year 1 2 3 4 5__
Cash flows now for the target 60 80 100 125 150
Additional cash flows (synergy) 40 70 100 125 150
Total cash flows (after merger) 100 150 200 250 300
Risk free rate of return 4%
Beta for this project (the company after merging) 1.47
Market risk premium 5%
Pre-tax cost of debt 8%
Marginal after tax rate 25%
Number of shares outstanding for the target company (millions) 10
Current market price per share for the target company $51
Percentage of the acquisition financed with debt 40%
Percentage of the acquisition financed with common equity 60%
What is the after tax cost of debt for this merger (as we did in chapter 16)?
What is the after tax cost of common equity for this merger (as we did in chapter 16)?
What is the weighted average cost of capital for this acquisition candidate (as we did in chapter 16)?
Please run a net present value using the WACC calculated above with the total cash flows from the target (given above) to determine the maximum price per share you are willing to pay for this target candidate?
Explanation / Answer
1)
after cost of debt = 8% * (1-0.25) = 6%
2)after tax cost of common equity = 4% + 1.47 * 5% = 11.35%
3)
WACC = 40% * 6% + 60% * 11.35% = 9.21%
4)
NPV = 100/1.0921 + 150/1.0921^2 + 200/1.0921^3 + 250/1.0921^4 + 300/1.0921^5
= 739.74 million
maximum price per share = 739.74/10 = 73.97
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.