TransWorld Communications Inc., a large telecommunications company,is evaluating the possible acquisition of Georgia Cable Company (GCC), a regional cable company. TransWorld€™s analysts project the following post-merger data for GCC (in thousands of dollars):

  

If the acquisition is made, it will occur on January 1, 2018. All cash flows shown in the income statements are assumed to occur at the end of the year. GCC currently has a capital structure of 40% debt, but Trans World would increase that to 50% if the acquisition were made. GCC,if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. GCC€™s current market-determined beta is 1.40, and its investment bankers think that its beta would rise to 1.50 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 65% of sales, but it could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to TransWorld€™s shareholders. The risk-free rate is 8%, and the market risk premium is 4%.

a. What is the appropriate discount rate for valuing the acquisition?

b. What is the continuing value?

c. What is the value of GCC to TransWorld?

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2019 2021 2018 2020 Net sales $450 $518 $555 $600 Selling and administrative expense 45 53 60 68 Interest 18 21 24 27 Tax rate after merger 35% Cost of goods sold as a percent of sales 65% Beta after merger 1.50 Risk-free rate 8% Market risk premium 4% Continuing growth rate of cash flow available to TransWorld 7%