2018 2019 2020 2021 Net sales $450 $518 $555 $600 Selling and administrative expense 45 53 60 68 Interest 18 21 24 27 Tax rate after merger 35% Cost of goods sold as a percent of sales 65% Beta after merger 1.50 Risk-free rate 8% Market risk premium 4% Continuing growth rate of cash flow available to TransWorld 7%
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
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
thousands of dollars):
If the acquisition is made, it will occur on January 1, 2018. 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 1.40, and its investment bankers
think that its beta would rise to 1.50 if the debt ratio were increased to 50%. The cost of goods
sold is expected to be 65% of sales, but it could vary somewhat.
funds would be used to replace worn-out equipment, so they would not be available to
TransWorld’s shareholders. The risk-free rate is 8%, and the market risk premium is 4%.
a. What is the appropriate discount rate for valuing the acquisition?
b. What is the continuing value?
c. What is the value of GCC to TransWorld?
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