Q1. Lee Enterprises and Jackson Distributors are considering a merger. Projectio

Question

Q1.

Lee Enterprises and Jackson Distributors are considering a merger. Projections for the coming year for the companies operating independently are as follows:

Lee Enterprises:
EBIT = $200,000
Change in Working Capital = $20,000
Capital Spending = $30,000
Depreciation Expense = $20,000

Jackson Distributors:
EBIT = $450,000
Change in Working Capital = $45,000
Capital Spending = $75,000
Depreciation Expense = $50,000

Before the merger, the firms have the same cost of capital of 14% and the same expected perpetual growth rate of 4%. After the merger, the combined firms are expected to have a cost of capital of 13% and a perpetual growth rate of 5%. The tax rate for both firms is 40%.

What is the pre-merger value of the combined firms?

Select one:

A. $1,800,000

B. $2,900,000

C. $3,400,000

D. None of the above

Q2.

Ancient Alloys Corp. is interested in acquiring Advanced Technologies, Inc., in the expectation that the acquisition would provide the combined firms with $4 million in tax-shield benefits. If this amount can be used to offset income by $1 million each year for the next four years, what is the present value of the expected tax-shield benefit? The cost of capital is 14%.

Select one:

A. $877,193

B. $2,913,712

C. $3,508,772

D. $4,203,686

Explanation / Answer

FCFF = EBIT*(1-tax rate) + Depreciation - Capex - WC

Lee

FCFF = 200000*(1-40%) + 20000 - 30000 - 20000 = 90000

Value = 90000*(1+4%) / (14% - 4%) = 936000

Jackson

FCFF = 450000*(1-40%) + 50000 - 70000 - 45000 = 205000

Value = 205000*(1+4%) / (14% - 4%) = 2132000

Total value = 936000 + 2132000 = 3068000 (Option D none of the above)

2)

PV = PMT * (1-(1+r)-n) / r

PV = 1000000  * (1-(1+14%)-4) / 14%

= 2913712 (Option B)

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