cemmond Optional question (15 points) You are a partner of Private Eq informatio

Question

cemmond Optional question (15 points) You are a partner of Private Eq information for the acquisition of the firm, ABC Corp (target firm), which is currently your project. The target firm is a private firm. uity Firm, Lion LLC (Acquiring firm) and you have the following Suggested bidding price for the target $147 million comparable firms of the target firm: unlevered cost of capital = 6.54% Five year estimation of free cash flow to the firm (FCF) and interest tax shields o FCF: 13 million (t-1), 7.4 million (t 2), -5.8 million (t-3), 1.4 million (t 4), and 10.3 million (t-5) o Pre-determined Interest tax shields: $2.3 million at t-1, $2.3 million at t-2, $2.3 million at t-3, $2.7 million at t-4, $2.8 million at t=5 Estimation of FCF at t-6 is $11 million (after t-6 and beyond, FCF will grow at the constant growth rate = 5% and cost of capital . 9%) Question : Perform NPV analysis for this project using APV method. (You should include discounted cash flows for five years as well as continuation value)

Explanation / Answer

Terminal Value in year 5, TV5 = FCF6 / (r - g) = 11 / (9% - 5%) = $275

Using APV, NPV = PV of FCF + PV of tax shield

PV of FCF = -FCF0 + FCF1 / (1 + r) + ... + (FCF5 + TV5) / (1 + r)^5

= -147 + 13 / 1.0654 + 7.4 / 1.0654^2 + ... + (10.3 + 275) / 1.0654^5

= $75.86

PV of tax shield = 2.3 / 1.0654 + 2.3 / 1.0654^2 + ... + 2.8 / 1.0654^5 = $10.22

=> NPV = $75.86 + $10.22 = $86.08

Year FCF TV Tax Shield 0 -$    147.00 1 $       13.00 $     2.30 2 $         7.40 $     2.30 3 -$        5.80 $     2.30 4 $         1.40 $     2.70 5 $       10.30 $ 275.00 $     2.80 6 $       11.00

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