Merger Analysis TransWorld Communications Inc., a large telecommunications compa
ID: 2727179 • Letter: M
Question
Merger Analysis
TransWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Georgia Cable Company (GCC), a regional cable company. TransWorld's analysts project the following post-merger data for GCC (in thousand of dollars):
If the acquisition is made, it will occur on January 1, 2015. All cash flows shown in the income statements are assumed to occur at the end of the year. GCC currently has a capital structure of 40% debt, but Trans World would increase that to 50% if the acquisition were made. GCC, if independent, would pay taxes at 20%; but its income would be taxed at 35% if it were consolidated. GCC's current market-determined beta is 1.2, and its investment bankers think that its beta will rise to 1.3 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 80% of sales, but could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to TransWorld's shareholders. The risk-free rate is 9%, and the market risk premium is 4%. Do not round intermediate calculations.
What is the appropriate discount rate for valuing the acquisition?
% (to 2 decimals)
What is the continuing value?
$---- thousand (to 1 decimal)
What is the value of GCC to TransWorld?
$---- thousand (to 1 decimal)
Explanation / Answer
Rf
9%
Per acqusition levered Beta
1.2
Pre acqusition debt equity ratio
40 : 60
tax rate per merger
20%
Calculation of Beta unlievered
0.782608696
From the above formula
Calculation of relivered Beta
Beta unlievered
0.782608696
Debt equity ratio post merger
50%
tax rate post merger
35%
calcutaion of beta unlivered form the above formula
1.036956522
calculation of Ke using beta levered as calculated above
Rf
9%
Beta
1.036956522
market risk premium
4%
Ke =
13.15%
Calculation of weighted average cost of capital
Ke
13.15%
Kd - since it is not specifically provided - risk free rate asssumed
9%
We
50%
Wd
50%
tax rate
35%
WACC / Discount rate
9.50%
calculation of treminal value / continuing value
Calculation of free cash flow
Projected post merger data - GCC
2015
2016
2017
2018
Net sales
$442
$513
$544
$584
GOGS
80% of sales
$353.60
$410.40
$435.20
$467.20
Selling and administrative expense
43
49
56
65
EBIT
$45.40
$53.60
$52.80
$51.80
Interest
18
21
24
27
EBT
$27.40
$32.60
$28.80
$24.80
Tax - after merger @
35%
$9.59
$11.41
$10.08
$8.68
EAT
$17.81
$21.19
$18.72
$16.12
Calculation of free Cash Flow
EBIT
$17.81
$21.19
$18.72
$16.12
EBIT *(1-tax rate ie 35%) = NOPAT
11.5765
13.7735
12.168
10.478
Less Capex
Not provided in question
Less change in working capital
Not provided in question
Add Depreciation
Provided - not to be considered
0
0
0
0
Free cash flow
11.5765
13.7735
12.168
10.478
Terminal value
244.5457
Free cash flow + terminal value
11.5765
13.7735
12.168
255.0237
Steady state calculation
Steady state growth
5%
sales - year 4 sales *staedy state growth
613.2
Nopat / sales of year 4
2%
NOPAT of steady state - slaes of steady state *2%
11.0019
Less Capex
0
Not provided in question
Less change in working capital
0
Not provided in question
Add Depreciation
0
Provided - not to be considered
Steady state free cash flow
11.0019
Year 4 terminal value - steady state cash flow / (WACC - growth rate)
244.5457357
11.0019 /( 9.50% - 5%)
Enterprize value = present value of free cash flow
Free cash flow
11.5765
13.7735
12.168
10.478
Terminal value
244.5457
Free cash flow + terminal value
11.5765
13.7735
12.168
255.0237
Discount rate -
9.50%
0.91
0.83
0.76
0.70
10.57166
11.4871
9.267149
177.369
Enterprize value = present value of free cash flow
208.6949158
Rf
9%
Per acqusition levered Beta
1.2
Pre acqusition debt equity ratio
40 : 60
tax rate per merger
20%
Calculation of Beta unlievered
0.782608696
From the above formula
Calculation of relivered Beta
Beta unlievered
0.782608696
Debt equity ratio post merger
50%
tax rate post merger
35%
calcutaion of beta unlivered form the above formula
1.036956522
calculation of Ke using beta levered as calculated above
Rf
9%
Beta
1.036956522
market risk premium
4%
Ke =
13.15%
Calculation of weighted average cost of capital
Ke
13.15%
Kd - since it is not specifically provided - risk free rate asssumed
9%
We
50%
Wd
50%
tax rate
35%
WACC / Discount rate
9.50%
calculation of treminal value / continuing value
Calculation of free cash flow
Projected post merger data - GCC
2015
2016
2017
2018
Net sales
$442
$513
$544
$584
GOGS
80% of sales
$353.60
$410.40
$435.20
$467.20
Selling and administrative expense
43
49
56
65
EBIT
$45.40
$53.60
$52.80
$51.80
Interest
18
21
24
27
EBT
$27.40
$32.60
$28.80
$24.80
Tax - after merger @
35%
$9.59
$11.41
$10.08
$8.68
EAT
$17.81
$21.19
$18.72
$16.12
Calculation of free Cash Flow
EBIT
$17.81
$21.19
$18.72
$16.12
EBIT *(1-tax rate ie 35%) = NOPAT
11.5765
13.7735
12.168
10.478
Less Capex
Not provided in question
Less change in working capital
Not provided in question
Add Depreciation
Provided - not to be considered
0
0
0
0
Free cash flow
11.5765
13.7735
12.168
10.478
Terminal value
244.5457
Free cash flow + terminal value
11.5765
13.7735
12.168
255.0237
Steady state calculation
Steady state growth
5%
sales - year 4 sales *staedy state growth
613.2
Nopat / sales of year 4
2%
NOPAT of steady state - slaes of steady state *2%
11.0019
Less Capex
0
Not provided in question
Less change in working capital
0
Not provided in question
Add Depreciation
0
Provided - not to be considered
Steady state free cash flow
11.0019
Year 4 terminal value - steady state cash flow / (WACC - growth rate)
244.5457357
11.0019 /( 9.50% - 5%)
Enterprize value = present value of free cash flow
Free cash flow
11.5765
13.7735
12.168
10.478
Terminal value
244.5457
Free cash flow + terminal value
11.5765
13.7735
12.168
255.0237
Discount rate -
9.50%
0.91
0.83
0.76
0.70
10.57166
11.4871
9.267149
177.369
Enterprize value = present value of free cash flow
208.6949158