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630 Fall 2010 Final Exam Template

# 630 Fall 2010 Final Exam Template - Global Internet...

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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 Risk-free rate 7% Market risk premium 6.5% Terminal growth rate of free cash flow 6.0% Pre-merger 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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b. 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 post-merger 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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630 Fall 2010 Final Exam Template - Global Internet...

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