8. Apilado Corporation is considering a merger with Vaccaro Company.

Vaccaro is a
publicly traded company, and its current beta is 1.30. Vaccaro has been barely profitable, so
it has paid an average of only 20% in taxes during the last several years. In addition, it uses
little debt, having a debt ratio of just 25%. If the acquisition were made, Apilado would
operate Vaccaro as a separate, wholly owned subsidiary. Apilado would pay taxes on a
consolidated basis and the tax rate would therefore increase to 35%. Apilado also would
increase the debt capitalization in the Vaccaro subsidiary to 40% of assets, which would
increase Apilados beta to 1.47. Apilados acquisition department estimates that Vaccaro if
acquired would produce the following net cash flows to Apilados shareholders ( $ in
millions):
Year
Net Cash flows
1
1.30
2
1.50
3
1.75
4
2.00
5 and beyond
Constant growth at 6%
These cash flows include all acquisition effects. Apilados cost of equity is 14%, it beta is
1.0, and its cost of debt is 10%. The risk free rate is 8%.
a. What discount rate should be used to discount the estimated cash flows? ( Hint: Use
Apilados risk premium )
b. What is the dollar value of Vaccaro to Apilado?
c. Vaccaro has 1.2 million common shares outstanding. What is the maximum price per
share that Apilado should offer for Vaccaro? If the tender offer is accepted at this price, what
will happen to Apilados stock price?
9. Van Buren currently expects to pay a yearend dividend of $2 a share ( D1 = $ 2). Van
Burens dividend is expected to grow at a constant rate of 5% a year, and its beta is 0.9. Risk
free rate is 5% and market risk premium is 6%.
i.
What is the current price of Van Burens stock?
ii.
Harrison estimates that if it acquires Van Buren the yearend dividend will remain at
$2 a share, but synergies will enable the dividend to grow at a constant rate of 7% a year (
instead of current 5%) Harrison also plans to increase the debt ratio of what would be its Van
Buren subsidiary the effect of this would be to raise Van Burens beta to 1.1. What is the
per share value of Van Buren to Harrison Corporation?
iii.
On the basis of your answers to i & ii if Harrison were to acquire Van Buren, what
would be the range of possible prices it could bid for each share of Van Buren common
stock?
10. Trans World Communications Inc. is evaluating the possible acquisition of Georgia
Cable Company (GCC), a regional cable company. TransWorlds analysts project the
following post merger data for GCC ( in thousands of dollar):
2009
2010
2011
2012
Net Sales
450
518
555
600
Selling and administration expenses 45
53
60
68

Interest
18
21
24
27
Tax rate after merger
35%
Cost of goods ratio
65%
Beta after merger
1.5
Risk free merger
8%
Market risk premium
4%
Terminal growth rate of cash flow available to TransWorld
7%
If the acquisition is made, it will occur on Jan. 1, 2009. 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 TransWorld 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. GCCs 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. Depreciation generated funds
would be used to replace worn out equipment, so they would not be available to
TransWorlds shareholders. The risk free rate is 8% and the market risk premium is 4%.
i. What is the appropriate discount rate for valuing the acquisition?
ii. What is the terminal value?
iii. What is the value of GCC to TransWorld?
11.
Box Company and Cox Company are planning to merge in an exchange of shares to
form Cox and Box Company. Their Balance sheets are as follows:
( Rs. In Millions)
Cox Company
Box Company
Fixed Assets
25
10
Current Assets
20
7.5
Total Assets
45
17.5
Share Capital ( F.V. per share - Rs.100)
20
5
Reserves and Surplus
10
10
Debt
15
2.5
Total Liabilities
45
17.5
The fair market value of the fixed assets and currents assets of Box Company was assessed at
Rs.20 M and Rs. 10 M respectively. What is the net asset value of each company and how
much should be the exchange ratio?