5. Brau Auto, a national autoparts chain, is considering purchasing a smaller ch

Question

5. Brau Auto, a national autoparts chain, is considering purchasing a smaller chain, South Georgia Parts (SGP). Brau's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values: Year 1 2 3 4 Free cash flow $1 $3 $3 $7 Unlevered horizon value 75 Tax shield 1 1 2 3 Horizon value of tax shield 32 Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Brau? a. $53.40 million b. $61.96 million c. $64.64 million d. $76.96 million e. $79.64 million

Explanation / Answer

Brau Auto, a national autoparts chain, is considering purchasing a smaller chain, South Georgia Parts (SGP). Brau's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values: Year Free cash flow Unlevered horizon value Tax shield Horizon value of tax shield 1 $1 2 $3 3 $3 1 1 2 4 $7 75 3 32 Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new d ebt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its postmerger tax rate would be 34%. The risk -free rate is 8% and the market risk premium is 4%. W hat is the value of SGP to Brau?

a. $53.40 million
b. $61.96 million -answer
c. $64.64 million
d. $76.96 million
e. $79.64 million

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