Acme Paper Company is looking to expand its operations and is considering purchasing Pretty Paper, Inc.  Acme currently has debt outstanding with a market value of $150 million and a YTM of 9%.  Acme’s market capitalization of $450 million and the required return on equity is 10%.  Pretty Paper, Inc. currently has debt outstanding with a market value of $20 million, and the forecasted EBIT for next year is $10 million.  EBIT is expected to grow at 5% per year for the next 5 years before slowing to 3% in perpetuity.  Networking capital, capital spending, and depreciation as a percentage of EBIT are expected to be 16%, 8%, and 6%, respectively for Pretty Paper, Inc.  Pretty Paper, Inc. has 2.5 million shares outstanding, and the tax rate for both companies is 35%. 

1.Based on the above numbers and forecasts, what is the maximum share price that Acme should be willing to pay for Pretty Paper, Inc.?

2.Instead of using perpetual growth rate in cash flows, you feel that the terminal value should be used to estimate the EV/EBITDA multiple.  If the appropriate EV/EBITDA multiple is 7, what is your new estimate of the maximum share price for the purchase?

please provide all necessary side calculations and explanations.

Answer rating: 100% (QA)

1 Maximum share price based on perpetual growth rate a Free cash flow to equity FCFE Next years EBIT is expected to be 10 million Using the given percentages for networking capital capital spending an... View the full answer