The CEO of the ESG Corp has hired you to advise her and her company about whether

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Question:

The CEO of the ESG Corp has hired you to advise her and her company about whether or not to acquire Greenerton, a privately held company with no outstanding debt. If ESG Corp moves forward with the acquisition, it will finance the deal with equity and no debt.

You have produced the following projections (in $ million) for Greenerton's revenues, costs of goods sold, and depreciation over the next two years (assume that today is 2020).

There are no other revenues or expenditures to consider. Today (in 2020), Greenerton's net working capital (NWC) is $26 million. For 2021 and 2022, you estimate that Greenerton's net working capital will be 10% of revenues.

Because neither ESG or Greenerton are publicly traded, you have gathered data about BlueSky, a publicly traded firm whose operations are similar in risk to Greenerton's. BlueSky has 200,000 shares outstanding, and they are currently trading at $42 a share. It also has $2.8 million in debt. BlueSky has an equity beta (betaβ_E) of 1.8, and the firm borrows at a rate of 5.6%.

The corporate tax rate is 40%, the market risk premium, E[R_m]-r_f, is 8%, and the risk-free rate is 4%.

a. What are Greenerton's free cash flows for 2021 and 2022?

b. What is the unlevered cost of capital (r_U) for BlueSky?

c. You can use the unlevered cost of capital (r_U) for BlueSky as the weighted average cost of capital (r_WACC) for the Greenerton acquisition. Write one to two sentences explaining why.

d. You estimate that Greenerton's free cash flows will grow at 5% forever after 2022. Calculate the terminal value of Greenerton at the end of 2022, and the maximum value that ESG should be willing to pay to acquire Greenerton.