Merger analysis Apilado Appliance Corporation is considering a merger with the V
ID: 2652368 • Letter: M
Question
Merger analysis
Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is a publicly traded company, and its current beta is 1.35. Vaccaro has been barely profitable, so it has paid an average of only 30% in taxes during the last several years. In addition, it uses little debt, having a debt ratio of just 20%.
If the acquisition were made, Apilado would operate Vaccaro as a separate, wholly owned subsidiary. Apilado would pay taxes on a consolidated basis, and the tax rate would therefore increase to 40%. Apilado also would increase the debt capitalization in the Vaccaro subsidiary to 40% of assets, which would increase its beta to 1.69. Apilado's acquisition department estimates that Vaccaro, if acquired, would produce the following net cash flows to Apilado's shareholders (in millions of dollars):
These cash flows include all acquisition effects. Apilado's cost of equity is 13%, its beta is 1.0, and its cost of debt is 9%. The risk-free rate is 7%.
What discount rate should be used to discount the estimated cash flows? (Hint: Use Apilado's rs to determine the market risk premium.)
Round your answer to two decimal places.
%
What is the dollar value of Vaccaro to Apilado? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $13,000,000 should be entered as 13.
$ million
Vaccaro has 1.5 million common shares outstanding. What is the maximum price per share that Apilado should offer for Vaccaro? Round your answer to the nearest cent.
$
Explanation / Answer
Solution-1
Since Apilado’s b = 1
So,
RPM = kM - kRF = 13% -7%
RPM = kM - kRF = 6%
ks = kRF + (kM - kRF)b
ks = 7%+(13%-7%)*1.69
ks = 17.14%
Solution-2
Years
Cash flows
Discount Rate
Present Values
1
$1.30
0.8537
$1.11
2
$1.50
0.7288
$1.09
3
$1.75
0.6221
$ 1.09
4
$19.30
0.5311
$10.25
5
$2.10
0.4534
$0.95
The value of Vaccaro
$14.49
4th value of cash flows = Dividend (5) / Cost of equity-growth rate
4th value of cash flows = $2.10 / 0.1241
4th value of cash flows = $17.30
Solution-3
PMax = Value of (Vaccaro's) / Number of Shares Outstanding
PMax = $14.49 / 1.5
PMax = $9.66
The Apilado price remains at its current price.
Years
Cash flows
Discount Rate
Present Values
1
$1.30
0.8537
$1.11
2
$1.50
0.7288
$1.09
3
$1.75
0.6221
$ 1.09
4
$19.30
0.5311
$10.25
5
$2.10
0.4534
$0.95
The value of Vaccaro
$14.49