Question

Using the Adjusted present value (APV) approach:

BTR Warehousing, which is considering the acquisition of Globo-Chem Co., estimates that acquiring Globo-Chem will result in an incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company:

Data Collected (in millions of dollars)
	Year 1	Year 2	Year 3
EBIT	$11.0	$13.2	$16.5
Interest expense	3.0	3.3	3.6
Debt	34.1	40.3	43.4
Total net operating capital	105.1	107.1	109.1

Globo-Chem Co. is a publicly traded company, and its market-determined pre-merger beta is 1.60. You also have the following information about the company and the projected statements:

•	Globo-Chem currently has a $16.00 million market value of equity and $10.40 million in debt.
•	The risk-free rate is 5%, there is a 7.10% market risk premium, and the Capital Asset Pricing Model produces a pre-merger required rate of return on equity rsLsL of 16.36%.
•	Globo-Chem’s cost of debt is 7.00% at a tax rate of 30%.
•	The projections assume that the company will have a post-horizon growth rate of 4.00%.
•	Current total net operating capital is $102.0, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisition is $31 million.
•	The firm does not have any nonoperating assets such as marketable securities.

Given this information, use the adjusted present value (APV) approach to calculate the following values involved in merger analysis. (Note: Only round intermediate calculations when entering them as a final answer.)

	Value
Unlevered cost of equity	12.67% (other choices: 9.2%, 14.16%, 10.69%)
Horizon value of unlevered cash flows	(110.5, 114.56, 53.06, 86.85)
Horizon value of tax shield	(12.96, 12.46, 11.88, 20.76)
Unlevered value of operations	(95.47, 96.55, 61.40, 90.85)
Value of tax shield	(50.60, 11.40, 15.62, 61.58)
Value of operations	Value of operations: (157.05, 112, 106.47, 107.95) Thus, the total value of Globo-Chem’s equity is (146.65, 86.15, 51, 97.55). Suppose BTR Warehousing plans to use more debt in the first few years of the acquisition of Globo-Chem Co. Assuming that using more debt will not lead to an increase in bankruptcy costs for BTR Warehousing, the interest tax shields and the value of the tax shield in the analysis, will (decrease/increase) , leading to a (higher/lower) value of operations of the acquired firm. The APV approach is considered useful for valuing acquisition targets, because the method involves finding the values of the unlevered firm and the interest tax shield separately and then summing those values. Why is it difficult to value certain types of acquisitions using the corporate valuation model? A) The acquiring firm usually assumes the debt of the target firm. Thus, old debt with different coupon rates usually becomes a part of the acquisition deal. B) The acquiring firm immediately retires the target firm’s old debt. Thus, the acquisition deal consists of only new debt in its capital structure.

Answer 1

ponor C Answerin Now Here, The Un levered cost of equity: : E=16 Total Capital, D = 10.40 c = DHE С C c=10.404 16 C= 26.40 : Wd=0/0 10.4 26.4 wd = 39.39% .: We = 1- Wd 1-39,39%. We = 60.61%. There fore, = 16.36%, 8sL 80=7%. And Hence, anlevered Cost of equity, k = wdxoot Wexosh K = 39.39%87% + 60.61% X 16.36% 19.67 %. Horizon value of cinlevered cash flow sir Parameter Linkage yearo year 1 Year 2 Year 3 EBIL 11,00 13.20 16.50 Taxrate, I 30% 30% 30% Total net operating 102.00 105.10 (07.10 109.10 Increase in het B= Difference of 3.10 2.00 2.00 successive AS operating capital Un levered Bee cash flow EBIT *(1-1)-B 4.60 7.24 3=9.5. :: Horizon value of inlevered. cash flows = G+(1-3)/(kg

IPS ho- (2) 9.55*(1 +4%) (12.67% -4% 114.56 Then Here, Horizon value of tax shield. Parameter Linkage Year o Year 1 Year 2 Year 3 Interest expense T 3.00 3.30 3.60 Interest Heal shield 2 x (1-1) 0.90 0.99 ITS3=1.08 Horizon value of tax shield is - IT532 (149) (kng ) 1.08 x (174% 12.67% -4%) , = 12.96 = Then Here: parameter Linkage Yearo Yearl Xear? Year 3 Unlevered free cash 4.60 flows 7.24 9.55 Horizon value B 114.56 Discount factor c= (1+12 6795 0.8875 0.78 77 06 699) PV of unlevered cash D = AXC 4.08 flows 5.70 6.68 PV of horizon value =BXC 80.09 Unlevered value of sum of all D's f 96.55 Un levered value of operations = PV of all the future unlevered operatione 96.55

> And Here, value of tax shield, parameter Linkage Year Year 1 Year 2 Year Interest too shield А 0.90 0.99 1.08 Horizon value B В 112.95 Discount factor c= (1+12.67 % 0.8875 0.7877 0.699 PV of Interes tan Shield DEA to 0.80 0.78 0.76 PV of horizon value E =BX C 9.05 value of tax shields sum of all is fE 11.40 ith V Ren value of operations ve Unlevered value of operations + value of tax Shield 96.55 + 11.40 107.95 . The total value of Globo -Chemis equity is V-D = 107.95 - 10.40 97.55. ..het, suppose BTR ware housing plans to use more debt in the first few years of the acquisition of Globo Chemco. Assuming that using more debt will no lead an in crease in bank ouptcy costs for BTR ware hoping and the value of the tax shield in the analysis, will increase leading to a higher' value of operation of the acquised from the correct option is B.