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Merger Valuation

Pit Row Auto, a national auto parts chain, is considering purchasing a smaller chain, Southern Auto. Pit Row's analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117 million in Year 4. The Year 4 cash flow includes a horizon value of $107 million.

Assume all cash flows occur at the end of the year. Southern is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, if it is undertaken and Southern would retain its current $15 million in debt and issue new debt in order to continue targeting a 30% debt level. The interest rate will remain the same. Southern's pre- merger beta is estimated to be 2.0, and its post-merger tax rate would be 34 percent. The risk-free rate is 2 percent, and the market risk premium is 6 percent.

What is the value of Southern Auto's equity to Pit Row Auto?