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Hager’s Home Repair Company, a regional hardware chain, which specializes in “do-it-yourself” materials and equipment rentals, is considering an acquisition of Lyon Lighting (LL). Doug Zona, Hager’s treasurer and your boss, has been asked to place a value on the target and he has enlisted your help.
LL has 20 million shares of stock trading at $12 per share. Security analysts estimate LL’s beta to be 1.25. The risk-free rate is 5.5% and the market risk premium is 4%. LL’s capital structure is 20% financed with debt at an 8% interest rate; any additional debt due to the acquisition also will have an 8% rate. LL has a 25% federal-plus-state tax rate, which will not change due to the acquisition.
The following data incorporate expected synergies and required levels of total net operating capital for LL should Hager’s complete the acquisition. The
Note:
aDebt is added on the first day of the year, so the 2019 debt is LL’s debt prior to the acquisition.
Hager’s management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Hager’s board:
Why can’t we estimate LL’s value to Hager’s by discounting the FCFs at the WACC? What method is appropriate? Use the projections and other data to determine the LL division’s
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Chapter 22 Solutions
FINANCIAL MANAGEMENT
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