Merger analysis Apilado Appliance Corporation is considering a merger with the V
ID: 2652441 • 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
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.
Market risk premium = (Apilado's cost of equity - risk-free rate)/Beta
Market risk premium = (13%-7%)/1
Market risk premium = 6%
Cost of Equity of Vaccaro to Apilado = risk-free rate + Market risk premium*Beta
Cost of Equity of Vaccaro to Apilado = 7 + 6*1.69
Cost of Equity of Vaccaro to Apilado =17.14%
After tax cost of debt of Vaccaro to Apilado = 9%*(1-40%)
After tax cost of debt of Vaccaro to Apilado = 5.40%
WACC (Kc)= (1-40%)*17.14 + 40%*5.40
WACC (Kc)= 12.44%
Answer
Discount rate should be used to discount the estimated cash flows = 12.44%
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.
Horizon Value at year 4 = Expected Cash flow in year 5/(Kc - g)
Horizon Value at year 4 = 2*1.05/(12.44%-5%)
Horizon Value at year 4 = 28.23
Dollar value of Vaccaro to Apilado = Expected Cash flow in year 1/(1+Kc) + Expected Cash flow in year 2/(1+Kc)^2 + Expected Cash flow in year 3/(1+Kc)^3 + Expected Cash flow in year 4/(1+Kc)^4 + Horizon Value at year 4/(1+Kc)^4
Dollar value of Vaccaro to Apilado = 1.30/1.1244 + 1.50/1.1244^2 + 1.75/1.1244^3 + 2/1.1244^4 + 28.23/1.1244^4
Dollar value of Vaccaro to Apilado = 22.49 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.
Maximum price per share that Apilado should offer for Vaccaro = Dollar value of Vaccaro to Apilado/common shares outstanding
Maximum price per share that Apilado should offer for Vaccaro = 22.49/1.5
Maximum price per share that Apilado should offer for Vaccaro = $ 14.99