2011
2012
2013
2014
2015
Net sales
$500
$600
$700
$760
$806
Selling and administrative expense
60
70
80
90
96
Interest
30
40
45
60
74
Tax rate of MCI before the merger
30%
Tax rate after merger
35%
Cost of goods sold as a % of sales
65%
Debt ratio (percent financed with debt) before the merger
30%
Cost of debt before merger
9%
Debt ratio (percent financed with debt) after the merger
40%
Cost of debt after merger
10%
Beta of MCI
1.40
Riskfree rate
7%
Market risk premium
6.5%
Terminal growth rate of free cash flow
6.0%
Premerger debt (in thousands)
$400
a.
What is the appropriate discount rate for valuing the acquisition?
The unlevered cost of equity should be used to discount the FCFs, tax shields and horizon value.
Step 1: Find the levered cost of equity at old capital structure.
Step 2: Find the unlevered cost of equity.
Global Internet Services., a large Internet service provider, is evaluating the possible acquisition o
Connections Inc. (MCI), a regional Internet service provider.
GIS's analysts project the following
for MCI (in thousands of dollars):
r
L
=
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View Full Documentb.
What is the horizon, or continuing, value?
What is the value of MCI to GIS's shareholders?
2011
2012
2013
2014
2015
Sales
Cost of Goods Sold (incl. depreciation)
Gross Profit
Selling/admin. costs
EBIT
Interest
EBT
Taxes
Net Income
EBIT
Taxes on EBIT
NOPAT
Investment in net operating capital
0
0
0
0
0
FCF
$0.0
$0.0
$0.0
$0.0
$0.0
To calculate the horizon
value of the tax shields, we must determine the tax shield for 2015.
From this point, we can derive horizon value from the basic DCF framework.
The tax shield is the interest multiplied by the postmerger tax rate.
2011
2012
2013
2014
2015
Interest
0.0
0.0
0.0
0.0
0.0
Tax shield
=
*
(1+g)
/

=
*
/

=
/
=
To calculate the value of the tax shields add the horizon value of the tax shields to the 2015 tax shi
r
U
=
Before we can proceed with this problem, we must generate pro forma income statements for MC
the proposed merger so we can calculate free cash flow and interest tax shields.
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 Spring '10
 dina
 Generally Accepted Accounting Principles, Weighted average cost of capital

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