Merger Valuation with Change in Capital Structure VolWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Bulldog Cable Company (BCC), a regional cable company. VolWorld's analysts project the following post-merger data for BCC (in thousands of dollars, with a December 3 1 year-end):

If the acquisition is made, it will occur on January 1, 2010. All cash flows shown in the income statements are assumed to occur at the end of the year. BCC currently has a capital structure of 40% debt, which costs 10%, but over the next 4 years VolWorld would increase that to 50%, and the target capital structure would be reached by the start of 2014. BCC, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. BCC's current market-determined beta is 1. 40. The cost of goods sold is expected to be 65% of sales.
a. What is the unlevered cost of equity for BCC?
b. What are the free cash flows and interest tax shields for the first 5 years?
c. What is BCC's horizon value of interest tax shields and unlevered horizon value?
d. What is the value of BCC's equity to VolWorld's shareholders if BCC has $300,000 in debt outstandingnow?

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2009 2010 20 2012 2013 2014 Net sales Selling and administrative expense Interee Total net operating capital Tax rate after merger; 35% Cost of goods sold as a percent S450 $518 555 60 S 643 68 73 17 52 54 5800 50 930 1,075 ,150 45 53 60 40 5 of sales: 65%, BCCs pe-merger beta: 1.40 Risk-free rate: 6% Market risk preถา un: 4% Terminal growth rate of free cash flows: 7%