Financial Management: Theory & Practice
Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
Question
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Chapter 22, Problem 6P

a.

Summary Introduction

To calculate: Company FS pre-merger unlevered horizon value. Also, the Year 0 unlevered value.

a.

Expert Solution
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Explanation of Solution

Given information:

Company FS pre-merger unlevered cost of equity: 8%

Pre-tax cost of debt: 6%

Tax rate: 25%

Terminal growth rate of free cash flow: 5%

Company FS outstanding shares: 800 million

Calculation of Horizon value of unlevered operations (HVUL) pre-merger:

Formula to calculate HVUL:

HVUL=Free cash flow in Year4×(1+terminalgrowthrateoffreecashflow)rUterminalgrowthrateoffreecashflow

Substitute $2,000 for free cash flow in year 4, 5% for terminal growth rate of free cash flow and 8% for (rU) to calculate HVUL.

HVUL=$2,000×(1+5%)8%5%=$2,1003%=$70,000

Hence, the HVUL is $70,000.

Calculation of year 0 unlevered value:

ValueUL=[Freecash flows(1+Unlevered cost of equity)N]=[$1,600(1+8%)+$1,800(1+8%)2+$1,900(1+8%)3+$2,000+$70,000(1+8%)4]=$57,455.122

b.

Summary Introduction

To calculate: Company FS pre-merger horizon value tax shield. Also, calculate year 0 tax shield value.

b.

Expert Solution
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Explanation of Solution

Calculation of tax shield:

ParticularsYear 1($)Year 2($)Year 3($)Year 4($)
Interest474486492498
Tax shield (Interest×Tax rate of Company ACC after merger)118.50121.50123.00124.50

Calculation of Horizon value of tax shield (HVTS):

Formula to calculate HVTS:

HVTS=Taxshield×(1+terminalgrowthrateoffreecashflow)rUterminalgrowthrateoffreecashflow

Substitute $124.50 for tax shield, 5% for terminal growth rate of free cash flow and 8% for (rU) to calculate HVTS.

HVTS=$124.50×(1+5%)8%5%=$4,357.50

Hence, the HVTS is $4,357.50.

Calculation of year 0 tax shield value:

ValueTS=[Tax shield(1+Unlevered cost of equity)N]=[$118.5(1+8%)+$121.5(1+8%)2+$123(1+8%)3+$124.5+$4,357.5(1+8%)4]=$3,605.93

c.

Summary Introduction

To calculate: Company FS pre-merger value of levered operations and value of equity. Also compute the minimum stock price.

c.

Expert Solution
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Explanation of Solution

Calculation of value of levered operations:

Valueofleveredoperations=Unleveredopertaions+Value of tax shield=$57,455.12+$3,605.93=$61,061.05

Hence, value of levered operations is $61,061.05.

Calculation of value of equity:

Value of Equity=(Value of levered operationsValue of pre-merger debt proportion)=$61,061.05$7,700=$53,361.05

Hence, value of equity is $53,361.05.

Calculation of stock price:

Stockprice=ValueofequityOutstandingShares=$53,361.05800Shares=$66.70

Hence, minimum stock price is $66.70 per share.

d.

Summary Introduction

To calculate: Company FS post-merger unlevered horizon value to Company CR. Also, compute year 0 unlevered value.

d.

Expert Solution
Check Mark

Explanation of Solution

Calculation of Horizon value of unlevered operations (HVUL) post-merger:

Formula to calculate HVUL:

HVUL=Free cash flow in Year4×(1+terminalgrowthrateoffreecashflow)rUterminalgrowthrateoffreecashflow

Substitute $2,200 for free cash flow in year 4, 5% for terminal growth rate of free cash flow and 8% for (rU) to calculate HVUL.

HVUL=$2,200×(1+5%)8%5%=$77,000

Hence, the HVUL is $77,000.

Calculation of year 0 unlevered value:

ValueUL=[Freecash flows(1+Unlevered cost of equity)N]=[$1,700(1+8%)+$2,000(1+8%)2+$2,100(1+8%)3+$2,200+$77,000(1+8%)4]=$63,170.164

e.

Summary Introduction

To calculate: Company FS post-merger horizon value tax shield. Also, calculate year 0 tax shield value.

e.

Expert Solution
Check Mark

Explanation of Solution

Calculation of tax shield:

ParticularsYear 1($)Year 2($)Year 3($)Year 4($)
Interest1,3201,3381,3441,350
Tax shield (Interest×Tax rate of Company ACC after merger)330.00334.50336.00337.50

Calculation of Horizon value of tax shield (HVTS):

Formula to calculate HVTS:

HVTS=Taxshield×(1+terminalgrowthrateoffreecashflow)rUterminalgrowthrateoffreecashflow

Substitute $337.50 for tax shield, 5% for terminal growth rate of free cash flow and 8% for (rU) to calculate HVTS.

HVTS=$337.50×(1+5%)8%5%=$11,812.50

Hence, the HVTS is $11,812.50.

Calculation of year 0 tax shield value:

ValueTS=[Tax shield(1+Unlevered cost of equity)N]=[$330(1+8%)+$334.5(1+8%)2+$336(1+8%)3+$337.5+$11,812.5(1+8%)4]=$9,789.67

f.

Summary Introduction

To calculate: Company FS post-merger value of levered operations and value of equity. Also compute the minimum stock price.

f.

Expert Solution
Check Mark

Explanation of Solution

Calculation of value of levered operations:

Valueofleveredoperations=Unleveredopertaions+Value of tax shield=$63,170.16+$9,789.67=$72,959.83

Hence, value of levered operations is $72,959.83.

Calculation of value of equity:

Value of Equity=(Value of levered operationsValue of pre-merger debt proportion)=$72,959.83$7,700=$65,259.83

Hence, value of equity is $65,259.83.

Calculation of stock price:

Stockprice=ValueofequityOutstandingShares=$65,259.83800Shares=$81.57

Hence, maximum stock price is $81.57 per share.

g.

Summary Introduction

To calculate: The percentage of Company FS pre-merger and post-merger capital structure at year 4 consisted of debt. Also, the increase in value to Company CR due to improved free cash flow.

g.

Expert Solution
Check Mark

Explanation of Solution

Calculation of pre-merger capital structure consisted of debt:

Pre-mergerathorizon=(DebtathorizonHorizonValueunlevered+Horizonvaluetaxshield)=($8,300$70,000+$4,357.5)=11.2%

Hence, Company FS consisted of 11.2% of debt in its overall capital structure.

Calculation of post-merger capital structure consisted of debt:

Pre-mergerathorizon=(DebtathorizonHorizonValueunlevered+Horizonvaluetaxshield)=($22,500$77,000+$11,812.5)=25.3%

Hence, Company FS consisted of 25.3% of debt in its overall capital structure.

Calculation of increase in the value due to free cash flows:

Increaseinvalue=(Post-merger value of operationsPre-merger value of operations)=$63,170.16$57,455.12=$5,715.04

Hence, increase in value due to free cash flows is $5,715.04.

Calculation of increase in value due to change in capital structure:

Increaseinvalue=(Post-merger value of tax shieldPre-merger value of tac shield)=$9,789.67$3,605.93=$6,183.74

Hence, increase due to change in capital structure is $6,183.74.

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