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

Wellington Industries is considering an acquisition of Orators Telecom Inc. . Wellington Industries estimates that acquiring Orators 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	7.0	8.4	10.5
Interest expense	5.0	5.5	6.0
Debt	34.1	40.3	43.4
Total net operating capital	123.6	126.0	128.4

Orators 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:

	Orators currently has a $14.00 million market value of equity and $9.10 million in debt.
	The risk-free rate is 3.5% with a 5.60% market risk premium, and the Capital Asset Pricing Model produces a pre-merger required rate of return on equity rsLrsL of 11.34%.
	Oratorss cost of debt is 5.50% at a tax rate of 40%.
	The projections assume that the company will have a post-horizon growth rate of 4.50%.
	Current total net operating capital is $120.0 million, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisition is $31 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
Value of FCFE

The estimated value of Oratorss operations after the merger is than the market value of Oratorss equity. This means that the wealth of Oratorss shareholders will if it merges with Wellington rather than remaining as a stand-alone corporation.

True or False: The horizon value in the FCFE approach is different from the horizon value in the adjusted present value (APV) approach. The horizon value in the FCFE approach is only for equity, whereas the horizon value in the APV approach is for the total value of operations.

True

False