Question

4. Merger valuation and discounted cash flows When an acquirer assesses a potential target, the price the acquirer is willing to pay should be based on the value of: O The target firm's equity O The target fim's debt O The target firm's total corporate value (debt and equity) Consider the following scenario: Sto Hard Holdings Co. (SHH) is considering an acquisition of Mall Toys Co. (MTC), and estimates that acquiring MTC will result in incremental after-tax net cash flows in years 1-3 of $10.0 million, $15.0 million, and $18.0 million, respectively After the first three years, the incremental cash flows contributed by the MTC acquisition are expected to grow at a constant rate of 6% per year. SHH's current beta is 1.20, but its post-merger beta is expected to be 1.56. The risk-free rate is 4%, and the market risk premium is 6.10%. Based on this information, complete the following table by selecting the appropriate values: Value Post-merger cost of equity Projected value of the cash flows at the end of three years The value of Mall Toys Co. (MTC)'s contribution to Sto Hard Holdings Co. (SHH) Mall Toys Co. (MTC) has 3 million shares of common stock outstanding. What is the largest tender offer Sto Har Holdings Co. (SHH) should make on each of Mall Toys Co. (MTC)'s shares? O $68.73 O $82.48 O $54.98

Answer 1

Beta	1.56
Risk free rate of return	4.00%
Market risk premium	6.10%
Required rate of return using CPAM model	=Risk free rate+(Markter risk premium)*Security beta
	=4.00%+(6.10%)*1.56
Required rate of return	13.516%
Last cash flow	18
Rate of return	14%
Growth Rate	6%
Projected value of cash flow at Y3	= last cash flow * (1+Growth rate)/(Rate of return-Growth Rate)
	= 18*(1+6%)/(13.516%-6%)
Projected value of cash flow at Y3	253.86
		13.52%
		NPV@ 0.13516
Year	Cash flow	PV factor	PV-Cash flow
1	10.00	0.881	8.81
2	15.00	0.776	11.64
3	18.00	0.684	12.31
3	253.86	0.684	173.55
		Total PV	206.30
So value of company	206.30
No of shares	3
Per share value can be offered	68.73
So option 1 is correct