Is provided return on the market is currently 15

This preview shows page 5 - 8 out of 13 pages.

Suppose that the following information with regard to the capital structure of Meineken Ltd. is provided: Return on the market is currently 15%, while return on Government Bonds amounts to 8% Meineken’s beta is 1.5 The preference shares have a dividend rate of 5% The debentures are 20 year, 10% coupon rate (compounded annually) instruments with a par value of R 250 000 The long term loan has an interest rate of 12% The marginal tax rate is 30%
Image of page 5

Subscribe to view the full document.

The Effect of Synergies & Changes in Control on Free Cash Flow & Cost of Capital - One large motivator for M&A transactions – undervalued companies - Major justification for M&A transactions – potential synergies that can be unlocked - Synergies can be realised through a variety of channels – lower costs, improvement in future growth opportunities - There are two types of synergies 1.) Financial Synergies 2.) Operational Synergies - Must incorporate the operational and financial synergies into the valuation of the target company Incorporating the effect of operating synergies that result from an M&A transaction - Increased turnover due to improved distribution networks , decreased operating costs due to economies of scale or improved production efficiency. - In order to incorporate these effects – must adjust the expected FCF or growth assumption 6 | P a g e Calculate Cost of Ordinary Shares (K OS ) with CAPM : K OS = R f + ẞ (R m – R f ) = 8% + 1.5 ( 15% - 8%) = 18.5% Calculate the Cost of Preference Shares (K PS ) : K PS = __Dividend _ = 5% x R 6 = 3.75% Market Price R 8 Calculate the Cost of Debentures (K DI ): PV = - 300 000 N = 20 PMT = 10% x 250 000 = 25 000 FV = 250 000 I/YR = ?? 7.97% Calculate the company’s WACC: WACC = w os k os + w ps k ps + w di k di (1 – T) WACC = 18.5% ( 800 000 / 1650000 ) + 3.75%( 400 000 / 1650000 ) + 7.97%(0.70) ( 300 000 / 1650000 ) + 12%(0.70)( 150000 / 1650000 ) = 11.66% Example (Page 118) Reconsider Meineken example. Suppose that after a revaluation of the firm, WCB Ltd. estimated significant operating synergies Improvements envisaged after business combination takes place: Gross Profit Margin expected to increase to 80% Current operating costs are estimated to decrease to R10 000 from the previous level of R15 000. The operating costs are expected to grow in line with turnover. Expected demand for Meineken’s products (and hence turnover) will increase by 15% per year for the next three years, and that turnover will increase by 6% thereafter. Net operating working capital requirement is expected to decrease to 7.5% of turnover Current capital expenditure on fixed assets is expected to remain at R20 000 Depreciation and capital expenditure is expected to increase in line with the growth in turnover.
Image of page 6
In the above example – operating synergies increased the value of the target company significantly. If these synergies had been ignored – value of the transaction would have been significantly underestimated . Incorporating the effect of financial synergies that occur as a result of M&A transactions - Synergies due to financial changes implemented during the business combination - Includes tax savings, effect of increased leverage on cost of capital, effect of obtaining sufficient cash flows to finance investment opportunities that previously couldn’t afford.
Image of page 7

Subscribe to view the full document.

Image of page 8

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes