RTE Telecom Inc., which is considering the acquisition of Globo - Chem Co . , estimates that
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Question:
RTE Telecom Inc., which is considering the acquisition of GloboChem Co estimates that acquiring GloboChem will result in an incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company:
Data Collected in millions of dollars
Year Year Year
EBIT $ $ $
Interest expense
Debt
Total net operating capital
GloboChem Co is a publicly traded company, and its marketdetermined premerger beta is You also have the following information about the company and the projected statements:
GloboChem currently has a $ million market value of equity and $ million in debt.
The riskfree rate is there is a market risk premium, and the Capital Asset Pricing Model produces a premerger required rate of return on equity rsL
of
GloboChems cost of debt is at a tax rate of
The projections assume that the company will have a posthorizon growth rate of
Current total net operating capital is $ and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisition is $ million.
The firm does not have any nonoperating assets such as marketable securities
Given this information, use the adjusted present value APV approach to calculate the following values involved in merger analysis. Note: Only round intermediate calculations when entering them as a final answer.
Value
Unlevered cost of equity
Horizon value of unlevered cash flows
Horizon value of tax shield
Unlevered value of operations
Value of tax shield
Value of operations
Thus, the total value of GloboChems equity is
Suppose RTE Telecom Inc. plans to use more debt in the first few years of the acquisition of GloboChem Co Assuming that using more debt will not lead to an increase in bankruptcy costs for RTE Telecom Inc., the interest tax shields and the value of the tax shield in the analysis, will leading to a value of operations of the acquired firm.
The APV approach is considered useful for valuing acquisition targets, because the method involves finding the values of the unlevered firm and the interest tax shield separately and then summing those values. Why is it difficult to value certain types of acquisitions using the corporate valuation model?
Because the acquisition is usually financed with equity and no new debt, the proportion of debt in the capital structure remains constant after the acquisition.
Because the acquisition is usually financed with new debt that will be repaid rapidly, the proportion of debt in the capital structure changes after the acquisition.
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