Marston Marble Corporation is considering a merger with the Conroy Concrete Comp

Question

Marston Marble Corporation is considering a merger with the Conroy Concrete

Company. Conroy is a publicly traded company, and its beta is 1.30. Conroy has

been barely profitable, so it has paid an average of only 20% in taxes during the last

several years. In addition, it uses little debt; its target ratio is just 25%, with the cost

of debt 9%.

If the acquisition were made, Marston would operate Conroy as a separate, wholly

owned subsidiary. Marston would pay taxes on a consolidated basis, and the tax rate

would therefore increase to 35%. Marston also would increase the debt capitalization

in the Conroy subsidiary to wd = 40%, for a total of $22.27 million in debt by the

end of Year 4, and pay 9.5% on the debt. Marston%u2019 s acquisition department estimates

that Conroy, if acquired, would generate the following free cash flows and interest

expenses (in millions of dollars) in Years 1%u2013 5:

Year Free Cash Flows Interest Expense

1 $1.30 $1.2

2 1.50 1.7

3 1.75 2.8

4 2.00 2.1

5 2.12 ?

In Year 5, Conroy%u2019 s interest expense would be based on its beginning-of-year (that is,

the end-of-Year-4) debt, and in subsequent years both interest expense and free cash

flows are projected to grow at a rate of 6%.

These cash flows include all acquisition effects. Marston%u2019 s cost of equity is 10.5%,

its beta is 1.0, and its cost of debt is 9.5%. The risk-free rate is 6%, and the market

risk premium is 4.5%.

a. What is the value of Conroy%u2019 s unlevered operations, and what is the value of

Conroy%u2019 s tax shields under the proposed merger and financing arrangements?

b. What is the dollar value of Conroy%u2019 s operations? If Conroy has $10 million in

debt outstanding, how much would Marston be willing to pay for Conroy?

Explanation / Answer

The solution explains three problems - 1. Calculation of value of Conroy Concrete Company for merger with Marston Marble. 2. Calculation of value of operations and current price of stock for Vadell. 3. Unlevered value of Vandell and value of tax shield for Vandell for merger with Hastings Corporation

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