TransWorld Communications Inc., a large telecommunications company, is evaluatin

Question

TransWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Georgia Cable Company (GCC), a regional cable company. TransWorld's analysts project the following postmerger data for GCC (in thousands of dollars):

If the acquisition is made, it will occur on January 1, 2012. All cash flows shown in the income statements are assumed to occur at the end of the year. GCC currently has a capital structure of 40% debt, but TransWorld would increase that to 50% if the acquisition were made. GCC, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. GCC'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 TransWorld's shareholders. The risk-free rate is 5%, and the market risk premium is 5%.

a. What is the appropriate discount rate for valuing the acquisition? Round your answer to two decimal places.

b. What is the terminal value? Enter your answer in thousands. For example, an answer of $13,000 should be entered as 13. Round your answer to two decimal places.

c. What is the value of GCC to TransWorld? Enter your answer in thousands. For example, an answer of $13,000 should be entered as 13. Round your answer to two decimal places.

2012 2013 2014 2015 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 percent of sales 65% Beta after merger 1.50 Risk-free rate 5% Market risk premium 5% Terminal growth rate of cash flow available to TransWorld 5%

Explanation / Answer

INPUT DATA: 2002 2003 2004 2005 Net sales $450 $518 $555 $600 COGS 65.00% 293 337 361 390 Sell/adm exp 45 53 60 68 Interest 18 21 24 27 Net income 61 70 72 75 Terminal value of cash flows 0 0 0 1,143 Net cash flow to TransWorld $61 $70 $72 $1,217 Beta after merger 1.5 Debt ratio after merger 50% Risk-free rate 8% Tax rate after merger 35% Market risk premium 4% Terminal growth rate 7.00% KEY OUTPUT: Cost of equity 14.0% Value of acquisition $877 Terminal value $1,143

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