Following is a table of projected after tax cash flows, their respective discoun
ID: 2657134 • Letter: F
Question
Following is a table of projected after tax cash flows, their respective discount rates, and values after the acquisition of DrugShop Limited (DSL) by Lawslob Enterprises (LLE). Fill in the blanks and calculate the stock price of the new firm if it has debt/equity ratio of 3/5 and 100 million shares outstanding.
Net Cash Flow
($ million) starting Growth Discount Value
one year from now Rate (%) Rate (%) ($ million)
DSL (on its own) 180 3 ---- 1500
LLE (on its own) 800 -2 10.5 ----
Acquisition Benefits 49 4 ---- 500
Rev. Enhancement 20 6 14 ----
Cost Reduction 20 4 16.5 ----
Tax Shelters 9 2 12 ----
DSL+LLE 1029 2 ---- ----
Explanation / Answer
DSL Value (standalone) = $ 1500 million
LLE Net Cash Flow = $ 800 million, Growth Rate = - 2 % and Discount Rate = 10.5 %
LLE Value (Standalone) = 800 / (0.105-(-2)) = $ 6400 million
Acquisition Benefits Value = $ 500 million
Total Combined Firm Value = DSL Value + LLE Value + Acquisition Benefits = 1500 + 6400 + 500 = $ 8400 million
Combined Net Cash Flow = $ 1029 million and Combined firm growth rate = 2 %
Let the discount rate be r for the combined firm
Therefore, 8400 = 1029 / (r-0.02)
r = 0.1425 or 14.25%
Debt - Equity Ratio of Combined Firm = 3/5
Debt Value = (3/8) x 8400 = $ 3150 million and Equity Value = (5/8) x 8400 = $ 5250 million
Number of Outstanding Shares = 100 million
Stock Price of Combined Firm = 5250 / 100 = $ 52.5