Question
A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The
A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target companys equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the targets cash flows and sell it for 12 times free cash flow in year five. Projected free cash flows and selling price are as follows.
Free cash flow: Year 1 $31 million / Year 2 $46 million / Year 3 $51 million / Year 4 $56 million / Year 5 $56 million
selling price: Year 5 $672 million
Total free cash flows: Year 1 $31 million / Year 2 $46 million / Year 3 $51 million / Year 4 $56 million / Year 5 $728 million
To finance the purchase, the investors have negotiated a $460 million, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition.
Additional information:
Tax rate | 40 | percent |
Risk-free interest rate | 3 | percent |
Market risk premium | 5 | percent |
Estimate the present value of the interest tax shields on the acquisition debt discounted at KA.
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