You have been asked to assess the value of synergy in a merger of TriMedia Productions, a

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Question:

You have been asked to assess the value of synergy in a merger of TriMedia Productions, a firm that produces movies, with Leppard Records, a record company. The following table summarizes the current debt ratios and other relevant statistics for the two firms:

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Both firms are at their optimal debt ratios prior to the merger and are fairly valued; they are in stable growth and expect to grow 5% a year forever. After the merger, however, it is anticipated that the optimal debt ratio for the combined firm will be 30%, and that the cost of debt for the combined firm at this debt ratio will be 7.5%. The current riskfree rate is 6% and the market risk premium is 4%, estimate the value of synergy in this merger.

(The tax rate for both firms is 40%)

2. Satellite Telecommunications Inc. is a firm in significant financial trouble. The firm reported an EBITDA of - $ 100 million last year on revenues of $ 1000 million. You expect revenues to grow 30% a year for the next 3 years and the EBITDA as a percent of revenues to be –5% in year 1, 5% in year 2 and 25% after that. The firm has substantially over invested in plant and equipment in the last few years and will reduce its capital expenditures to $ 50 million a year for the next 3 years, while depreciation will remain at $ 100 million a year for the next 3 years. Non-cash working capital is expected to be 5% of revenues. After year 3, the firm will grow 4% a year forever, and maintain a return on capital of 10%. The cost of capital will be 12% for the next 3 years and 10% thereafter. The firm has a net operating loss carryforward of $ 150 million currently and the marginal tax rate is 40%.

a. Estimate the free cashflows to the firm for the next 3 years.

b. Estimate the terminal value at the end of year 3.

c. Estimate the value of the firm today.