Ronson Inc; a technology company, is evaluating the possible acquisition of Blak
ID: 2658075 • Letter: R
Question
Ronson Inc; a technology company, is evaluating the possible acquisition of Blake equipment company. If the acquisition is made, it will occur on January 1, 2009. All cash flows shown in the income statements are assumed to occur at the end of the year. Blake currently has a capital structure of 40% debt, but Ronson would increase that to 50% if the acquisition were made. Blake, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. Blake’s current market-determined beta is 1.40, and its investment bankers think that its beta would rise to 1.50 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 65% of sales, but it could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to Ronson’s shareholders. The risk-free rate is 8%, and the market risk premium is 4%.
a. What is the appropriate discount rate for valuing the acquisition?
b. What is the terminal value?
c. What is the value of Blake to Ronson?
d. Suppose, Blake has 120,000 shares outstanding. What is the maximum per share price Ronson should offer Blake?
Ronson management project the following post-merger financial data (thousands of dollars
2009
2010
2011
2012
Net Sales
$450
$518
$555
$600
Selling and Administrative Expense
45
53
60
68
Interest
18
21
24
27
Tax Rate after merger
35%
Cost of goods sold as a % of sales
65%
Beta after merger
1.5%
Risk-Free rate
8%
Market risk premium
4%
Terminal growth rate of cash flow available to Madison
7%
2009
2010
2011
2012
Sales
$450.00
$518.00
$555.00
$600.00
Cost of Goods Sold (65%)
292.50
336.70
Gross Profit
157.5
181.3
Selling/Admin Cost
45.00
53.00
EBIT
112.50
128.30
Interest
18.00
21.00
EBT
94.50
107.30
Taxes (35%)
33.10
37.60
Net Income/Cash Flow
$61.40
$69.70
*In this scenario, we state that net income and net cash flow are equal. This assumption arises from the fact that depreciation-generated funds would be used to replace worn-out equipment, and would not be available to shareholders.
To calculate the terminal value, we must determine the net cash flow for 2013. This is derived as the 2012 net cash flow expanded at the terminal growth rate of cash flows. From this point, we can derive terminal value from the basic DCF framework.
Ronson Inc; a technology company, is evaluating the possible acquisition of Blake equipment company. If the acquisition is made, it will occur on January 1, 2009. All cash flows shown in the income statements are assumed to occur at the end of the year. Blake currently has a capital structure of 40% debt, but Ronson would increase that to 50% if the acquisition were made. Blake, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. Blake’s current market-determined beta is 1.40, and its investment bankers think that its beta would rise to 1.50 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 65% of sales, but it could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to Ronson’s shareholders. The risk-free rate is 8%, and the market risk premium is 4%.
Explanation / Answer
1) In this question we are valuing the firm to buy out the equity or share holders of the company and will use free cash flow to equity which in this case is equal to net Income since depreciation-generated funds would be used to replace worn out equipment and would not be available to shareholders, therefore the appropriate discount rate to calculate the value of all the stake of equity holders of the target company would be cost of equity calculated by using the CAPM
CAPM = Rf+ Beta(Market risk premium)
= 8% + 1.5(4%) = 14%
B) The terminal value is as shown below
The terminal value as shown in the table is 1142.6
Calculation: Terminal Value= 74.8(1.07)/.14-.07
C) The value of blake to Ronson is 769 USD, as shown in above table
Calculation: In excel find NPV using the formula =NPV(14%,0,Cashflows Y1-Y4)
Note: The year zero cash flow is put 0 because there is no investment being put at this stage, and we are trying to find out the value of company
D) The maximum per share price is 769/120000 = $.0064
2009 2010 2011 2012 Sales 450 518 555 600 Cost of Goods Sold (65%) 292.5 336.7 360.75 390 Gross Profit 157.5 181.3 194 210 Selling/Admin Cost 45 53 60 68 EBIT 112.5 128.3 134 142 Interest 18 21 24 27 EBT 94.5 107.3 110 115 Taxes (35%) 33.1 37.6 38.6 40.3 Net Income/Cash Flow 61.4 69.7 71.7 74.8 Terminal Value 1142.6 Total cash flow 61.4 69.7 71.7 1217.4 Cost of Equity 14% NPV 769.0Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.