Martin Technologies Inc., a large electronics company, is evaluating the possibl
ID: 2743915 • Letter: M
Question
Martin Technologies Inc., a large electronics company, is evaluating the possible acquisition of Columbia Electronics, a regional electronics company. Martin’s analysts project the following post-merger data for Columbia (in millions of dollars): 2015 2016 2017 2018 Net sales $300 $425 $475 $550 Selling and administrative expense 40 50 60 75 Interest 25 30 35 40 Tax rate after merger 35% Cost of goods sold as a percent of sales 75% Beta after merger 1.2250 Risk-free rate 4% Market risk premium 8% Continuing growth rate of cash flow available to Martin 5% If the acquisition is made, it will occur on January 1, 2015. All cash flows shown in the income statements are assumed to occur at the end of the year. Columbia currently has a capital structure of 40% debt, but Martin would increase that to 50% if the acquisition were made. Columbia, if independent, would pay taxes at 20%; but its income would be taxed at 35% if it were consolidated. Columbia’s current market-determined beta is 1.15, and its investment bankers think that its beta would rise to 1.2250 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 75% 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 Martin’s shareholders. The risk-free rate is 4%, and the market risk premium is 8%. What is the appropriate discount rate for valuing the acquisition? % (to 4 decimals)
Explanation / Answer
Decreased cash flow as a result of merger in % = EAT in case of merger/EAT in case of no merger.
So, appropriate discount rate For valaution will be cost of equity before merger.
Columbia current level after acquisition Beta 1.150 1.225 Rf( risk free rate) 4.0000% 4.0000% Rm( market risk premium) 8.0000% 8.0000% Ke = Rf + Beta(Rm-Rf) 8.6000% 8.9000% Capital structure: Debt 40.0000% 50.0000% Capital structure: Equity 60.0000% 50.0000% Cost of equity using WACC approach = Ke*Equity in % 5.1600% 4.4500% Post merger Growth for columbia as per martin's In billion's of dollar 2015 2016 2017 2018 Particulars 1 2 3 4 Net sales $ 300.0000 $ 425.0000 $ 475.0000 $ 550.0000 COGS $ 225.0000 $ 318.7500 $ 356.2500 $ 412.5000 Selling and administrative expenses $ 40.0000 $ 50.0000 $ 60.0000 $ 75.0000 Interest $ 25.0000 $ 30.0000 $ 35.0000 $ 40.0000 EBT (earnings before tax) $ 10.0000 $ 26.2500 $ 23.7500 $ 22.5000 Less: Taxes @ 35% $ 3.5000 $ 9.1875 $ 8.3125 $ 7.8750 EAT (earnings after tax) $ 6.5000 $ 17.0625 $ 15.4375 $ 14.6250 Cash flow available to martin $ 0.3250 $ 0.8531 $ 0.7719 $ 0.7313 Amount available $ 6.18 $ 16.21 $ 14.67 $ 13.89 Growth for columbia if merger with martin doesnot happen In billion's of dollar 2015 2016 2017 2018 Particulars 1 2 3 4 Net sales $ 300.0000 $ 425.0000 $ 475.0000 $ 550.0000 COGS $ 225.0000 $ 318.7500 $ 356.2500 $ 412.5000 Selling and administrative expenses $ 40.0000 $ 50.0000 $ 60.0000 $ 75.0000 Interest $ 25.0000 $ 30.0000 $ 35.0000 $ 40.0000 EBT (earnings before tax) $ 10.0000 $ 26.2500 $ 23.7500 $ 22.5000 Less: Taxes @ 20% $ 2.0000 $ 5.2500 $ 4.7500 $ 4.5000 EAT (earnings after tax) $ 8.0000 $ 21.0000 $ 19.0000 $ 18.0000Decreased cash flow as a result of merger in % = EAT in case of merger/EAT in case of no merger.
So, appropriate discount rate For valaution will be cost of equity before merger.
77.19% 77.19% 77.19% 77.19%Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.