Hager's Home Repair Company, a regional hardware chain, which specializes in do-it-yourself materials and equipment rentals,...

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Hager's Home Repair Company, a regional hardware chain, which specializes in "do-it-yourself" materials and equipment rentals, is considering an acquisition of Lyon Lighting (LL). Doug Zona, Hager's treasurer and your boss, has been asked to place a value on the target and he has enlisted your help. LL has 20 million shares of stock trading at $12 per share. Security analysts estimate LL's beta to be 1.25. The risk-free rate is 5.5% and the market risk premium is 4%. LL's capital structure is 20% financed with debt at an 8% interest rate; any additional debt due to the acquisition also will have an 8% rate. LL has a 25% federal-plus-state tax rate, which will not change due to the acquisition. The following data incorporate expected synergies and required levels of total net operating capital for LL should Hager's complete the acquisition. The forecasted interest expense includes the combined interest on LL's existing debt and on new debt. After 2026, all items are expected to grow at a constant 6% rate. Hager's management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Hager's board: D. Why can't we estimate LL's value to Hager's by discounting the FCFs at the WACC? What method is appropriate? Use the projections and other data to determine the LL division's free cash flows and interest tax savings for 2022 through 2026. Notice that the LL division's sales are expected to grow rapidly during the first years before leveling off at a sustainable long-term growth rate. E. Conceptually, what is the appropriate discount rate to apply to the cash flows developed in part d? What is your actual estimate of this discount rate? F. What is the estimated unlevered horizon value? What is the current unlevered operating value? What is the horizon value of the interest tax savings? What is the current value of the interest tax savings? What is the current total value of the acquisition to Hager's shareholders? Suppose another firm were evaluating Lyon Lighting as an acquisition candidate. Would they obtain the same value? Explain. G. Should Hager's make an offer for Lyon Lighting? If so, how much should it offer per share? Hager's Home Repair Company, a regional hardware chain, which specializes in "do-it-yourself" materials and equipment rentals, is considering an acquisition of Lyon Lighting (LL). Doug Zona, Hager's treasurer and your boss, has been asked to place a value on the target and he has enlisted your help. LL has 20 million shares of stock trading at $12 per share. Security analysts estimate LL's beta to be 1.25. The risk-free rate is 5.5% and the market risk premium is 4%. LL's capital structure is 20% financed with debt at an 8% interest rate; any additional debt due to the acquisition also will have an 8% rate. LL has a 25% federal-plus-state tax rate, which will not change due to the acquisition. The following data incorporate expected synergies and required levels of total net operating capital for LL should Hager's complete the acquisition. The forecasted interest expense includes the combined interest on LL's existing debt and on new debt. After 2026, all items are expected to grow at a constant 6% rate. Hager's management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Hager's board: D. Why can't we estimate LL's value to Hager's by discounting the FCFs at the WACC? What method is appropriate? Use the projections and other data to determine the LL division's free cash flows and interest tax savings for 2022 through 2026. Notice that the LL division's sales are expected to grow rapidly during the first years before leveling off at a sustainable long-term growth rate. E. Conceptually, what is the appropriate discount rate to apply to the cash flows developed in part d? What is your actual estimate of this discount rate? F. What is the estimated unlevered horizon value? What is the current unlevered operating value? What is the horizon value of the interest tax savings? What is the current value of the interest tax savings? What is the current total value of the acquisition to Hager's shareholders? Suppose another firm were evaluating Lyon Lighting as an acquisition candidate. Would they obtain the same value? Explain. G. Should Hager's make an offer for Lyon Lighting? If so, how much should it offer per share?