Question
Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is a publicly traded company, and its current beta is 1.30. Vaccaro
Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is a publicly traded company, and its current beta is 1.30. Vaccaro has been barely profitable, so it has paid an average of only 20% in taxes during the last several years. In addition, it uses little debt, having a debt ratio of just 25%. If the acquisition were made, Apilado would operate Vaccaro as a separate, wholly owned subsidiary.
Apilado would pay taxes on a consolidated basis, and the tax rate would therefore increase to 35%. Apilado also would increase the debt capitalization in the Vaccaro subsidiary to 40% of assets, which would increase its beta to 1.47. Apilado's acquisition department estimates that Vaccaro, if acquired, would produce the following net cash flows to Apilado's shareholders:
Year Net Cash Flows 1 $2,000,000 2 $2,307,692.31 3 $2,692,307.69 4 $3,076,923.07 5 and beyond Constant growth at 6%
These cash flows include all acquisition effects. Apilado's cost of equity is 14%, its beta is 1.0, and its cost of debt is 10%. The risk-free rate is 8%.
a) What discount rate should be used to discount the estimated cash flows? (Hint: Use Apilado's rs to determine the market risk premium.)
b) What is the terminal value?
c)What is the dollar value of Vaccaro to Apilado?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started