Question

END OF CHAPTER CASE STUDY: DID UNITED TECHNOLOGIES OVERPAY FOR ROCKWELL COLLINS? Case Study Objectives: To Illustrate • A methodology for determining if an acquirer overpaid for a target firm, • How sensitive discounted cash flow valuation is to changes in key assumptions, and • The limitations of discounted cash flow valuation methods. United Technologies (UT), a jet engine manufacturer, agreed to acquire aircraft parts company, Rockwell Collins (Rockwell), for $30 billion, including $2 billion in assumed Rockwell debt, on September 4, 2017. According to the terms of the deal, Rockwell shareholders are to receive $140 per share. The purchase price consists of $93.33 in cash plus $46.67 in UT stock. The purchase price represents an 18% premium to Rockwell's closing share price the day before the announce ment. UT's aerospace business will be combined with Rockwell Collins to create a new business to be called Collins Aerospace Systems. UT anticipates about $500 million annually in cost savings by the fourth year following closing. Rockwell had completed its acquisition of B/E Aerospace on April 13, 2017. Free cash flow to the firm (FCFF) is projected to be $750 million in 2017 compared to $700 million prior to the acquisition. Free cash flow to the firm is expected to grow at 7% annually through 2022 and 2% thereafter. The firm's beta is 1.22 and average borrowing cost is 4.8%. The equity risk premium is 5 percentage points. The 10 year Treasury bond rate is 2.2%. The debt to equity ratio is 1.39. The firm's cost of capital in the years beyond 2022 is expected to be one-half of one percentage point below its level during the 2018 to 2022 period. The firm's marginal tax rate is 40% and there is no cap on the tax deductibility of net interest expense. An analyst was asked if UT overpaid for Rockwell. She reasoned that to answer this question, she would have to estimate the standalone value of Rockwell and the present value of synergy. The upper limit on the purchase price should be the sum of the standalone value plus the present value of synergy. If the actual purchase price exceeded the upper limit, the firm would have overpaid for the Rockwell. In effect, UT would have transferred all the value created by combining the two firms (ie., anticipated synergy) to Rockwell shareholders. Discussion Questions 1. Estimate the firm's cost of equity and after tax cost of debt. 2. Estimate the firm's weighted average cost of capital. (Hint: Recall that the debt-to-total capital ratio is equal to the debt-to-equity ratio divided by one plus the debt-to-equity ratio) 3. What is the WAAC beyond 20227 4. Use the discounted cash flow method to determine the standalone value for Rockwell Collins. Show your work. 5. Assuming the free cash flows from synergy will remain level in perpetuity, estimate the after-tax present value of anticipated synergy? 6. What is the maximum purchase price United Technologies should pay for Rockwell Collins? Did United Technologies overpay? DI INTENTOLINAR OVERRAV ROR ROCKWELL

5. Assuming the free cash flows from synergy will remain level in perpetuity, estimate the after-tax present value of anticipated synergy?

Please show all steps.

Answer 1

Therefore taking into consideration, post tax PV of Synergy is 15518.54 Million USD.

in Million $ 2023 Calculation of WACC Financial Year Year 2017 0 2018 1 2019 2 2021 3 2022 4 Annual Cost Saving WACC Discounting factor 0 0 0 5.15% 5.15% 5.15% 1 0.951042 0.904482 500 500 16266.03 (Synergy starts from 4th Year) 5.15% 5.15% 2.07% 0.8602 0.818087 0.902457 Cost of Debt Tax Rate Post tax cost of debt 4.80% 40% 2.88% Cost of equity Present Value 0 0 0 430.1002 409.0435 14679.39 PV Of Synergy 15518.54 Risk free rate Beta Risk Premium 2.20% 1.22 5% Cost of equity 8.30% Discounting factor = 1/(1+C8)^C5 $!!!! Proportion of Debt Proportion of equity 0.582 0.418 PV = C7 * C9 uity PV of synergy sum(C11:H11) WACC = 5.15% Terminal Growth Rate 2.07%