Crane Rafting Corporation is considering an acquisition of Frost Ski Supplies. Frost has a pre-merger 8% unlevered cost of equity, 6% pre-tax cost of debt, and 25% tax rate. Its pre-merger forecasted free cash flows and debt are expected to grow at a constant 5% rate after Year 4. Frost has 800 million outstanding shares.

If Crane makes the acquisition, synergies will increase Frost?s free cash flows.

Crane will also add debt at Frost?s 6% rate. Crane?s tax rate is 25%. The post-merger forecasted free cash flows and debt are expected to grow at a constant 5% rate after Year 4.

Data for Frost?s pre-merger and post-merger FCF and debt are shown here:

a. What is Frost?s pre-merger unlevered horizon value? What is its Year-0 unlevered value?

b. What is Frost?s pre-merger horizon value tax shield? What is its Year-0 tax shield value? Assume debt is added on the first day of the year; that is, calculate interest expenses for Year t based on debt at Year t.

c. What is Frost?s current value of levered operations? What is its value of equity? What is the minimum stock price per share that Frost?s shareholders should accept?

d. What is Frost?s post-merger unlevered horizon value to Crane? What is its Year-0 unlevered value?

e. What is Frost?s post-merger horizon value tax shield to Crane? What is its Year-0 tax shield value? Assume debt is added on the first day of the year; that is, calculate interest expenses for Year t based on debt at Year t.

f. What is Frost?s post-merger Year-0 value of levered operations to Crane? What is its value of equity? (Hint: Remember that Crane assumes Frost?s debt and subsequently issues more debt.) What is the maximum stock price per share that Crane should offer?

g. What percentage of Frost?s pre-merger capital structure at Year 4 consisted of debt? You already have the values you need to calculate the total value at the horizon.

What percentage after the merger? How much of Frost?s post-merger increase in value to Crane is due to improved FCF?

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Frost: Pre-merger FCF (millions) Debt (millions) Year 1 Year 2 Year 0 Year 3 Year 4 $2,000 $1,900 $1,400 $1,600 $7,900 $1,800 $8,200 $7,700 $8,100 $8,300 Frost: Post-merger FCF (millions) Debt (millions) Year 2 Year 3 Year 4 Year 0 Year 1 $1,400 $1,700 $2,000 $2,100 $2,200 $7,700 $22,000 $22,300 $22,400 $22,500