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26 views4 pages

ex mon M and A

Uploaded by

leanhnguyet20304
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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1. Suppose Luther Industries is considering divesting one of its product lines.

The product line is


expected to generate free cash flows of $2 million per year, growing at a rate of 3% per year. Luther
has an equity cost of capital of 10%, a debt cost of capital of 7%, a marginal tax rate of 35%, and a
debt-equity ratio of 2. This product line is of average risk and Luther plans to maintain a constant debt-
equity ratio.
FCF1= 2 mil; g= 3%; Ke= 10%, Kd= 7%, t = 35% ; Debt to Equity ratio= 2/1
D/(E+D)= 2/(2+1)
E/(D+E)= 1/(2+1)

a. Luther's Unlevered cost of capital.


WACC of unlevered= E/(E+D) x Ke + D/(E+D) x kd = 1/3 x 10% + 2/3 x 7%= 0.08
WACC of levered cost= E/(E+D) x Ke + D/(E+D) x kdx (1-t) = 1/3 x 10% + 2/3 x 7%= 0.064
b. The unlevered value of Luther's Product Line.
Levered value = 2/(0.064-0.03)= 59.4 mil
UnLevered value = 2/(0.08-0.03)= 40 mil

2. Omicron Industries' Market Value Balance Sheet ($ Millions)


and Cost of Capital
Assets Liabilities Cost of Capital
Cash 0 Debt 200 Debt 6%
Other Assets 500 Equity 300 Equity 12%
τc 35%

Omicron Industries New Project Free Cash Flows


Year 0 1 2 3
Free Cash Flows ($100) $40 $50 $60

Assume that this new project is of average risk for Omicron and that the firm wants to hold constant
its debt to equity ratio.
a. Omicron's Unlevered cost of capital
Unlevered cost of capital = 200/(200+300) x 6% + 300/(200+300) x 12% = 0.096
b. The unlevered value of Omicron's new project.
Value = 40/(1+0.096)^1 + 50/(1+0.096)^2 + 60/(1+0.096)^3= $123.7
c. The interest tax shield provided by Omicron's new project
Levered WACC= 200/(200+300) x 6%x (1-0.35) + 300/(200+300) x 12% = 0.0876
Value = 40/(1+0.0876)^1 + 50/(1+0.0876)^2 + 60/(1+0.0876)^3= $125.96
Debt= D/E x Value= 200/(200+300) x 125.69= $50.28
Interest tax shield in year 1= debt x cost of debt x tax rate= 50.28 x 0.06 x 0.35= 1.056

3. Suppose that Rose Industries is considering the acquisition of another firm in its industry for $100
million. The acquisition is expected to increase Rose's free cash flow by $5 million the first year, and
this contribution is expected to grow at a rate of 3% every year there after. Rose currently maintains
a debt to equity ratio of 1, its marginal tax rate is 40%, its cost of debt rD is 6%, and its cost of equity
rE is 10%. Rose Industries will maintain a constant debt-equity ratio for the acquisition.

a. Rose's unlevered cost of capital


FCF 1= 5 mil; g= 3%; D to E= 1/1; t= 40%, kd= 6%; Ke= 10%
Unlevered WACC= 1/(1+1) x 0.1 + 1/(1+1) x 0.06 = 0.08
b. The unlevered value of Rose's acquisition
Unlevered value= 5/(0.08 – 0.03)= $100
c. Given that Rose issues new debt of $50 million initially to fund the acquisition, the present value of
the interest tax shield for this acquisition.
Interest tax shield= 50 x 0.06 x 0.4= 1.2 mil
PV of Interest tax shield = 1.2/ (0.08 – 0.03)= $24 mil
d. Given that Rose issues new debt of $50 million initially to fund the acquisition, the total value of
this acquisition using the APV method
Vl= Vu + PV of tax shield= 100 +24= $124 mil
4. Omicron Industries' Market Value Balance Sheet ($ Millions)
and Cost of Capital
Assets Liabilities Cost of Capital
Cash 0 Debt 200 Debt 6%
Other Assets 500 Equity 300 Equity 12%
τc 35%

Omicron Industries New Project Free Cash Flows


Year 0 1 2 3
Free Cash Flows ($100) $40 $50 $60

Assume that this new project is of average risk for Omicron and that the firm wants to hold constant
its debt to equity ratio.
WACC=(1-35%)*6%*200/500+300/500*12%=8.76%
Levered value = 40/(1+0.0876)^1 + 50/(1+0.0876)^2 + 60/(1+0.0876)^3= 125.687
new debt=200/500*125.69=50.28
ITS=50.28*35%*6%=1.056
Levered value1 = 50/(1+0.0876)^1 + 60/(1+0.0876)^2= $96.7
new debt1=200/500*96.7=38.68
ITS1=38.68*35%*6%=0.81
Levered value2 = 60/(1+0.0876)^1= $55.17
new debt2=200/500*55.17=22.06
ITS2=22.06*35%*6%=0.46
Unlevered r wacc = 300/500*12% + 200/500*6%=0.096
PV of ITS= 1.056 + 0.81/(1+0.096)^1 + 0.46/(1+0.096)^2 =

Calculate the present value of the interest tax shield provided by Omicron's new project.

5. Aardvark Industries is considering a project that will generate the following free cash flows:

Year 0 1 2 3
Free Cash Flows ($200) $100 $80 $60

You are also provided with the following market value balance sheet and information regarding
Aardvark's cost of capital:

Assets Liabilities Cost of Capital


Cash 0 Debt 400 Debt 7%
Other Assets 1000 Equity 600 Equity 12%
τc 35%

a. Aardvark's unlevered cost of equity.


Unlevered cost of equity= [1-D/(E+D)]x Ke + D/(E+D) x Kd= [1-400/(400+600)] x 0.12 +
400/(400+600) x 0.07= 0.1

b. The unlevered value of Aardvark's new project.


Unlevered WACC= 0.4 x 0.07 + 0.6x0.12= 0.1
Vu= 100/1.1 + 80/1.1^2 + 60/1.1^3 = $202.1
c. Suppose that to fund this new project, Aardvark borrows $120 with the principal to be paid in three
equal installments at the end each year. The present value of Aardvark's interest tax shield.
Debt 1= 120 x 0.07x0.35=
Debt 2= 80 x 0.07 x 0.35=
Debt 3 = 40 x 0.07x 0.35=
PV of ITS (10%)= $5.26
d. Suppose that to fund this new project, Aardvark borrows $120 with the principal to be paid in three
equal installments at the end each year. The levered value of Aardvark's new project.
Levered value= Vu + PV of ITS= 202.1 + 5.26= 207.36
6. Wyatt Oil is considering an investment in a new project with an unlevered cost of capital of 11%.
Wyatt's marginal corporate tax rate is 35% and its debt cost of capital is 6%. The project has free cash
flows of $25 million per year which are expected to decline by 3% per year.

a. If Wyatt adjusts its debt continuously to maintain a constant debt-equity ratio of 50%, then the
appropriate WACC for this new project.
WACC= Unlevered WACC – D/(E+D) x tax rate x Kd = 11% - 0.5/(1+0.5)x0.35x0.06= 10.3%
b. If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%, then the
appropriate WACC for this new project.

WACC= Unlevered WACC – D/(E+D) x tax rate x Kdx (1+unlevered WACC)/(1+Kd)= 11% -
0.5/(1+0.5)x0.35x0.06 x (1+0.11)/(1+0.06)= 0.10267

c. If Wyatt adjusts its debt continuously to maintain a constant debt-equity ratio of 50%, then the
value of this new project.
Value= 25 /(0.103 – (-0.03))= $187.96
d. If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%, then the
value of this new project.
Value= 25 /(0.10267 – (-0.03))= $188.44 mil

7.

Year 2006 2007 2008 2009


Increase in NWC 3,000 4,000 4,500 5,000
Capex 7,000 7,000 22,000 20,000
Net borrowing 0 10,000 12,000 12,000

Tax rate= income tax/pre tax= 2796/7988= 35%


A. Determine the firm's free cash flow (FCFE) for the year 2006, 2007
FCF= EBIT (1-t) + Dep – change in NWC – capex
FCF 2006= 14,788 x (1-0.35) + 5,450 – 3000 – 7,000=
FCF2006=14788*(1-35%)+5450-7000-3000=5062.2
FCFE= FCF + net borrowing – after tax interest exp
fcfe2006=5062.2+0-6800*(1-35%)=642.2
fcf2007=16411*(1-35%)+5405-7000-4000=5072.15
FCFE(2007)=5072.15+10,000-(1-35%)*6,800=10,652.15
B. Calculate the free cash flow to equity (FCFF) for the year 2006,2007

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