1. Merger analysis - Free cash flow to equity (FCFE) approach

Sunny Squirrel Fabricators Inc. is considering an acquisition of Purple Turtle Corp.. Sunny Squirrel Fabricators Inc. estimates that acquiring Purple Turtle will result in 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
	(Millions of dollars)	(Millions of dollars)	(Millions of dollars)
	Year 1	Year 2	Year 3
EBIT	16.0	19.2	24.0
Interest expense	4.0	4.4	4.8
Debt	30.8	36.4	39.2
Total net operating capital	121.5	123.9	126.3

Purple Turtle is a publicly traded company, and its market-determined pre-merger beta is 1.40. You also have the following information about the company and the projected statements:

	Purple Turtle currently has a $14.00 million market value of equity and $9.10 million in debt.
	The risk-free rate is 5.5% with a 7.60% market risk premium, and the Capital Asset Pricing Model produces a pre-merger required rate of return on equity rsLrsL of 16.14%.
	Purple Turtles cost of debt is 7.50% at a tax rate of 30%.
	The projections assume that the company will have a post-horizon growth rate of 6.00%.
	Current total net operating capital is $118.0 million, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisition is $28 million.
	The firm has no nonoperating assets, such as marketable securities.

With the given information, use the free cash flow to equity (FCFE) approach to calculate the following values involved in the merger analysis. (Note: Round your answer to two decimal places, but do not round intermediate calculations.)

	Value
FCFE horizon value	Options: (a. $155.31 million) ; (b. $158.52 million) ; (c. $133.73 million) ; (d. $144.68 million)
Value of FCFE	Options: (a. $118.82 million) ; (b. $136.77 million) ; (c. $49.42 million) ; (d. $117.87 million)

The estimated value of Purple Turtles operations after the merger is (more/less) than the market value of Purple Turtles equity. This means that the wealth of Purple Turtles shareholders will (increase/decrease) if it merges with Sunny Squirrel rather than remaining as a stand-alone corporation.

True or False: Like the corporate valuation model, the FCFE model can be applied only when the capital structure is constant.

True

False