Ch 21 Toolkit - Mergers, LBOs, Diverstitures and Holding Companies

Ch 21 Toolkit - Mergers, LBOs, Diverstitures and Holding Companies

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4/11/2010 Chapter 21. Tool Kit for Mergers, LBOs, Divestitures, and Holding Companies Problem Inputs Long-term growth rate 6% Tax rate 40% Initial debt 27 million Pre-merger value of Tutwiler's stock 63 million Number of shares of Tutwiler stock 10 million 7.0% Beta 1.2 5% 9% S (in millions) $62.50 D (in millions) $27.00 Tutwiler's Pre-Merger Cost of Equity and WACC = + Beta * = 7% + 1.2 * 5% = 13.00% = D/(S+D) = 30.1676% WACC = + WACC = 1.63% + 9.08% WACC = 10.7073% Following are projections from the worksheet labeled "Web 21A." Table 21-3: Projected Postmerger Cash Flows for the Tutwiler Subsidiary as of December 31 (Millions of Dollars) 1/1/11 12/31/11 12/31/12 12/31/13 12/31/14 12/31/15 . Net sales $105.0 $126.0 $151.0 $174.0 $191.0 . Costs of goods sold 80.0 94.0 113.0 129.3 142.0 . 10.0 12.0 13.0 15.0 16.0 . Depreciation 8.0 8.0 9.0 9.0 10.0 . EBIT 7.0 12.0 16.0 20.7 23.0 . 3.0 3.2 3.5 3.7 3.9 . 33.2 35.8 38.7 41.1 43.6 46.2 . Total net operating capital 116.0 117.0 121.0 125.0 131.0 138.0 . NOPAT = EBIT(1-T) 4.2 7.2 9.6 12.4 13.8 . Less net investment in operating capital 1.0 4.0 4.0 6.0 7.0 . Free cash flow 3.2 3.2 5.6 6.4 6.8 Panel C: APV Model Cash Flows . Free cash flow 3.2 3.2 5.6 6.4 6.8 . Interest tax savings = Interest(T) 1.2 1.3 1.4 1.5 1.6 Panel D: FCFE Model Cash Flows . Free cash flow 3.2 3.2 5.6 6.4 6.8 . Less A-T interest = Interest(1-T) 1.8 1.9 2.1 2.2 2.4 In theory, merger analysis is quite simple. The acquiring firm performs an analysis to value the target company. The acquiring firm then seeks to buy the firm at preferably below that estimated value. Meanwhile, the target company would only want to accept the offer is the price exceeds its value if operated independently. In practice, however, the process of merger analysis is much more involved and raises some difficult issues. While many valuation techniques exist, we shall focus upon the discounted cash flow method. Regardless of the method used, it is crucial to recognize that the target company typically will not continue to operate as a separate entity, but rather it becomes part of the acquiring firm's portfolio of risky assets. This is significant because the operational changes that may occur will affect the value of the business and must be considered. In addition, it is important to remember that the goal of merger evaluation is to value the target company's equity, because the business is acquired from the company's owners, not its creditors. For that reason, our focus will be the value of equity, not total value. ILLUSTRATION OF THE THREE VALUATION APPROACHES FOR A CONSTANT CAPITAL STRUCTURE (Section 21.9) r RF RP M r d r SL r RF RP M r SL r SL w d w d r d (1-T) w S r SL Panel A: Selected Items from Projected Financial Statements a Interest expense b Debt c Panel B: Corporate Valuation Model Cash Flows
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. 6.2 2.6 2.9 2.5 2.5 2.6 . FCFE 6.2 4.0 4.1 6.0 6.7 7.1 Notes: VALUATION USING THE CORPORATE VALUE MODEL First, calculate the horizon value at the end of the forecast period, assuming constant growth in FCF.
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Ch 21 Toolkit - Mergers, LBOs, Diverstitures and Holding Companies

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