4/19/2010 Chapter 21. 21-07 Build a Model 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 ACC 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 ACC 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 unlevered cost of equity? 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. 2011 2012 2013 2014 2015 Sales Cost of Goods Sold (incl. depreciation) Gross Profit Selling/admin. costs EBIT Interest EBT Taxes Net Income EBIT NOPAT Investment in net operating capital FCF We must determine the tax shields. 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.
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