Question $26(25$ marks$)$

Smitty's Home Repair Company, a regional hardware chain that specializes in $"$do$-$it$-$yourself" materials and equipment rentals is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition.Linda Wade, smitty's treasurer and your boss, has been asked to place a value on a potential target, Hill's Hardware, a small chain that operates in an adjacent state, and she has enlisted your help.

The table below indicates Wade's estimates of Hill's earnings potential if it came under Smitty's management $($in millions of dollars$).$ The interest expense listed here includes the interest$(1)$on Hill's existing debt, $(2)$on new debt that Smitty's would issue to help finance the acquisition, and $(3)$on new debt expected to be issued over time to help finance expansion within the new $"$H division", the code name given to the target firm. The retentions represent earnings that will be reinvested within the H division to help finance its growth.

Hill's Hardware currently used $40$ percent debt financing, and it pays federal$-$plus$-$state taxes at a $30$ percent rate. Security analysts estimate Hill's beta to be $1\mathrm{.}2.$ If the acquisition were to take place, Smitty's would increase Hill's debt ratio to $50$ percent, which would increase its beta to $1\mathrm{.}3.$ Further, because Smitty's highly profitable, taxes on the consolidated firm would be $40$ percent.Wade realizes that Hill's Hardware also generates depreciation cash flows, but she believes that these funds would have to be reinvested within the division to replace worn$-$out equipment.

Wade estimates the risk free rate to be $9$ percent and the market risk premium to be $4$ percent. She also estimates that the net cash flows after $2018$ will grow at a constant rate of $6$ percent

$\backslash$table$[[$Details$,2015,2016,2017,2018],[$Retentions$,$$$0\mathrm{.}0,$$$7\mathrm{.}5,$$$6\mathrm{.}0,$$$4\mathrm{.}5],[$Interest$,$$$3\mathrm{.}0,$$$4\mathrm{.}5,$$$4\mathrm{.}5,$$$6\mathrm{.}0],[$Selling Question $26(25$ marks$)$

Smitty's Home Repair Company, a regional hardware chain that specializes in $"$do$-$it$-$yourself" materials and equipment rentals is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition.Linda Wade, smitty's treasurer and your boss, has been asked to place a value on a potential target, Hill's Hardware, a small chain that operates in an adjacent state, and she has enlisted your help.

The table below indicates Wade's estimates of Hill's earnings potential if it came under Smitty's management $($in millions of dollars$).$ The interest expense listed here includes the interest$(1)$on Hill's existing debt, $(2)$on new debt that Smitty's would issue to help finance the acquisition, and $(3)$on new debt expected to be issued over time to help finance expansion within the new $"$H division", the code name given to the target firm. The retentions represent earnings that will be reinvested within the H division to help finance its growth.

Hill's Hardware currently used $40$ percent debt financing, and it pays federal$-$plus$-$state taxes at a $30$ percent rate. Security analysts estimate Hill's beta to be $1\mathrm{.}2.$ If the acquisition were to take place, Smitty's would increase Hill's debt ratio to $50$ percent, which would increase its beta to $1\mathrm{.}3.$ Further, because Smitty's highly profitable, taxes on the consolidated firm would be $40$ percent.Wade realizes that Hill's Hardware also generates depreciation cash flows, but she believes that these funds would have to be reinvested within the division to replace worn$-$out equipment.

Wade estimates the risk free rate to be $9$ percent and the market risk premium to be $4$ percent. She also estimates that the net cash flows after $2018$ will grow at a constant rate of $6$ percent

$\backslash$table$[[$Details$,2015,2016,2017,2018],[$Retentions$,$$$0\mathrm{.}0,$$$7\mathrm{.}5,$$$6\mathrm{.}0,$$$4\mathrm{.}5],[$Interest$,$$$3\mathrm{.}0,$$$4\mathrm{.}5,$$$4\mathrm{.}5,$$$6\mathrm{.}0],[$Selling