Question

Asgard Corp, is considering to purchase a smaller kingdom called Midgard. Asgard’s analysts project that the merger will result in the following incremental free cash flows, horizon values, and tax shields:

Year	1	2	3	4
Free cash flow	$2	$4	$4	$6
Unlevered horizon value				$80
Tax shield	$1	$2	$3	$4
Horizon value of tax shield				$30

Assume that all cash flows occur at the end of the year and are in millions. Midgard is currently financed with 40% debt at a rate of 9%. The acquisition would be made immediately, and if it is undertaken, Midgard would retain its current $12 million of debt and issue enough new debt to continue at the 40% target level. The interest rate would remain the same. Midgard's pre-merger beta is 2.5, and its post-merger tax rate would be 35%. The risk-free rate is 5.5% and the market risk premium is 5%.

Using the compressed adjusted present value approach, what is the value of Midgard to Asgard?

(Hint: You need to solve for rsL and rsU in order to get your discount rate, then solve for the APV).

$61.50 million

$69.94 million

$72.74 million

$84.86 million

$87.30 million

Answer 1