Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker\'s NOPA

Question

Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Laker is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Laker will need $10 million of net new investment in operating capital. Laker's marginal tax rate is 35%. After the second year, the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 6%. Blazer has determined that Laker's cost of equity is 16.5%, and Laker currently has no debt outstanding. Assume that all cash flows occur at the end of the year and that Blazer must pay $50 million to acquire Laker. What is the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.

Explanation / Answer

NOPAT(1)=$9 million.

So FCF(1)=$9 m

Ks=16.5%, g=6%

NOPAT(2) = $25 million ,int exp = $5 million, investment in operating capital = $10m, tax=35%

So FCF(2) = NOPAT(2) -35%*5 - 10 = 25-1.75-10 = $13.25m

After 2nd year, FCF grows at a const rate of 6%

hence FCF(3) = 13.25*(1+6%) = $14.05

SO Horizon Value at Y2 = FCF3/(Ks-g) = 14.05/(16.5%-6%) =$133.81

Value to Blazer of LaKer's equity = FCF1+FCF2+Horizon Value at Y2

= 9/(1+16.5%)^1 + 13.25/(1+16.5%)^2 + 133.81/(1+16.5%)^2

= $116.08

So NPV = -50+116.08 = $66.08 million

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