1. Learning Objective 21-5 Problem 21-1. Valuation Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 5% and the market risk premium is 5%. Van Buren currently expects to pay a year-end dividend of $2.30 a share (D1 = $2.30). Van Buren's dividend is expected to grow at a constant rate of 4% a year, and its beta is 0.7. What is the current price of Van Buren's stock? Round your answer to two decimal places. ________ -------------------------------------------------------------------------------- 2. Learning Objective 21-5 Problem 21-2. Merger valuation Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 4% and the market risk premium is 5%. Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.75 a share, but synergies will enable the dividend to grow at a constant rate of 9% a year (instead of the current 6%). Harrison also plans to increase the debt ratio of what would be its Van Buren subsidiary - the effect of this would be to raise Van Buren's beta to 1.3. What is the per-share value of Van Buren to Harrison Corporation? Round your answer to two decimal places. ________ -------------------------------------------------------------------------------- 3. Learning Objective 21-5 Problem 21-3. Merger bid Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 3% and the market risk premium is 7%. Van Buren currently expects to pay a year-end dividend of $2.55 a share (D1 = $2.55). Van Buren's dividend is expected to grow at a constant rate of 4% a year, and its beta is 0.8. Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.55 a share, but synergies will enable the dividend to grow at a constant rate of 9% a year (instead of the current 4%). Harrison also plans to increase the debt ratio of what would be its Van Buren subsidiary-the effect of this would be to raise Van Buren's beta to 1.4. If Harrison were to acquire Van Buren, what would be the range of possible prices that it could bid for each share of Van Buren common stock? (Hint: Calculate the current price of Van Buren's stock and the per-share value of Van Buren to Harrison Corporation.) Round your answers to two decimal places. a. Low bound. ? ________ b. High bound. ________ -------------------------------------------------------------------------------- 4. Learning Objective 21-5 Problem 21-4. Merger analysis Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is a publicly traded company, and its current beta is 1.35. Vaccaro has been barely profitable, so it has paid an average of only 30% in taxes during the last several years. In addition, it uses little debt, having a debt ratio of just 25%. If the acquisition were made, Apilado would operate Vaccaro as a separate, wholly owned subsidiary. Apilado would pay taxes on a consolidated basis, and the tax rate would therefore increase to 40%. Apilado also would increase the debt capitalization in the Vaccaro subsidiary to 50% of assets, which would increase its beta to 1.8. Apilado's acquisition department estimates that Vaccaro, if acquired, would produce the following net cash flows to Apilado's shareholders (in millions of dollars): Year Net Cash Flows -------------------------------------------------------------------------------- 1 $1.30 2 $1.50 3 $1.75 4 $2.00 5 and beyond Constant growth at 8% These cash flows include all acquisition effects. Apilado's cost of equity is 12%, its beta is 1.0, and its cost of debt is 10%. The risk-free rate is 4%. a. What discount rate should be used to discount the estimated cash flows? (Hint: Use Apilado's rs to determine the market risk premium.) Round your answer to two decimal places. ?% b. What is the dollar value of Vaccaro to Apilado? Round your answer to two decimal places. ??? m i l l i o n c. Vaccaro has 1.4 million common shares outstanding. What is the maximum price per share that Apilado should offer for Vaccaro? Round your answer to two decimal places. -------------------------------------------------------------------------------- 5. Learning Objective 21-5 Problem 21-5. Capital budgeting analysis The Stanley Stationery Shoppe wishes to acquire The Carlson Card Gallery for $380,000. Stanley expects the merger to provide incremental earnings of about $58,000 a year for 10 years. Ken Stanley has calculated the marginal cost of capital for this investment to be 9%. Conduct a capital budgeting analysis for Stanley to determine whether or not he should purchase The Carlson Card Gallery. _________________ -------------------------------------------------------------------------------- 6. Learning Objective 21-5 Problem 21-4. Merger analysis TransWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Georgia Cable Company (GCC), a regional cable company. TransWorld's analysts project the following postmerger data for GCC (in thousands of dollars): ? ? 2009 2010 2011 2012 -------------------------------------------------------------------------------- Net sales ? $450 $518 $555 $600 Selling and administrative expense ? 45 53 60 68 Interest ? 18 21 24 27 Tax rate after merger 35% ? ? ? ? Cost of goods sold as a percent of sales 65% ? ? ? ? Beta after merger 1.50 ? ? ? ? Risk-free rate 6% ? ? ? ? Market risk premium 5% ? ? ? ? Terminal growth rate of cash flow ? ? ? ? ? available to TransWorld 8% ? ? ? ? If the acquisition is made, it will occur on January 1, 2009. All cash flows shown in the income statements are assumed to occur at the end of the year. GCC currently has a capital structure of 40% debt, but TransWorld would increase that to 50% if the acquisition were made. GCC, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. GCC's current market-determined beta is 1.40, and its investment bankers think that its beta would rise to 1.50 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 65% of sales, but it could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to TransWorld's shareholders. The risk-free rate is 6%, and the market risk premium is 5%. a. What is the appropriate discount rate for valuing the acquisition? Round your answer to two decimal places. ?% b. What is the terminal value? Round your answer to two decimal places. c. What is the value of GCC to TransWorld? Round your answer to two decimal places