Can I get an explanation on how to answer these?
A H | D | L; | u | I: | r | u | n | I | .J H 6_Wansley Portal Inc., a large Internet service provider, is evaluating the possible acquisition of Alabama Connections 7_ Company [ACC], a regional Internet service provider. Wansley's analysts project the following post merger data for 8_Acc [in thousands of dollars}: 9 E M M M M M 1 Net sales $500 $600 $700 $760 $606 3 Selling and administrative expense 60 70 B0 90' 96 3 Interest 30 40 45 60 74 . E E If the acquisition is made, it will occur on January 1, 2021. All cash flows shown in the income statements are l assumed to occur at the end of the year. Acc currently has a capital structure of 30 percent debt, which costs 9 i percent, but Wansley would increase that to 40 percent debt, costing 10 percent if the acquisition were made. ACC, if E independent, would pay taxes at 25 percent, and its income would be taxed at 25 percent if it werre consolidated. 2LACC's current market-determined beta is 1.40. The cost of goods sold is expected to be 65 percent of sales. Gross 2; investment in operating assets is expected to be equal to depreciation--replacing worn out equipment, so net 2; investment in operating assets will be zero. The risk-free rate is 7 percent, and the market risk premium is 6.5 21 percent. Wansley currently has $400,000 in debt outstanding. Use the compressed APV model to answer the 2ifollowing questions. 21 2i Tax rate of me before the merger 25% 21 Tax rate after merger 25% 21 Cost of goods sold as a % of sales 65% 21 Debt ratio [percent nanced with debt} before the merger 30% Cost of debt before merger 9% :1 Debt ratio [percent nanced with debt} after the merger 40% :2 Cost of debt after merger 10% a Beta of ACC 1.40 34 7% Risk-free rate Risk-free rate 7% Market risk premium 6.5% Terminal growth rate of free cash flow 6.0% Pre-merger debt [in thousands} 5 400 a. What is the unlevered cost of equity? The unlevered cost of equity should be used to discount the FCFs, tax shields and horizon value. Step 1: Find the levered cost of equity at old capital structure. TL: Step 2: Find the unlevered cost of equity. T": b. What is the horizon value of the tax shields and the unlevered operations? What is the value of ACC's operations and the value of ACC's equity to Wansley's shareholders? Before we can proceed with this problem, we must generate pro forma income statements for ACC's operations after the proposed merger so we can calculate free cash flow and interest tax shields. 2021 2022 2023 Sales Cost of Goods Sold (incl. depreciation] 2024 2025 mgLTrnF-l- . Build a Model I G) HVTS 2025 Gross Prot Sellingfadmin. costs EBIT Interest EBT Taxes Net Income EBIT NOPAT Investment in net operating capital FCF * In this scenario, we state that investment in net operating capital is zero. This arises from the fact that the only needed investments are those needed to replace worn out capital, and that they equal depreciation. We must determine the tax shields. From this point, we can derive horizon value from the basic DCF framework. 111e tax shield is the interest multiplied by the post-merger tax rate. 2021 2022 2023 Interest 0.0 0.0 0.0 Tax shield HVTS 2025 TS2025 * [1+9] I II . a h. 2024 (r50 0.0 2025 0.0 9} 90 HVTS 2025 91 HVTS 2025 92 93 To calculate the value of the tax shields add the horizon value of the tax shields to the 2025 tax shield 94 to get the total tax shield cash flow in 2025. In the other years the total TS cash flow is just the annual TS 95 Then find the NPV of this stream of tax shields at the unlevered cost of equity. 96 97 2021 2022 2023 2024 2025 98 Total TS Cash Flows 99 100 NPV of TS Cash Flows This is the value of all of the tax shields. 101 102 To calculate the unlevered value of operations you need the unlevered horizon value and the 103 the annual free cash flows. 104 105 To calculate the unlevered horizon value, we just need the free cash flow for 2025 106 107 HVUL 2025 FCF 2025 (1+g) (SU g) 108 HVUL 2024 E - 109 HVUL 2025 E 110 HVUL 2025 E 111 112 To calculate the unlevered value of operations, add the unlevered horizon value to the free cash flow 113 in 2025 to get the total unlevered cash flow in 2025. In the other years the unlevered cash flow is 114 just the annual free cash flow. The unlevered value of operations is the NPV of the unlevered 115 cash flows at the unlevered cost of equity. 116 117 Year 2021 2022 2023 2024 2025117 Year 2021 2022 2023 2024 2025 118 Total unlevered CFs 119 120 NPV of unlevered CFs This is the unlevered value of operations 121 122 123 The value of operations is the value of the interest tax shields plus the unlevered value of operations 124 VTS + unlevered 125 Vops 126 Vops 127 128 129 To find the value of ACC to Wansley's shareholders take the value of operations, add in any non-operating 130 assets (there are non for ACC) and subtract off the debt. 131 132 Vops = 133 Debt 134 Equity
