Mergers and Acquisitions Lavender Repair Company, a regional hardware chain that specializes in "do it yourself" materials and equipment rentals, is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition. Doug Zona, Lavender's treasurer, and your boss, has been asked to place a value on a potential target, Lyons Lighting (LL), a chain that operates in several adjacent states, and he has enlisted your help. The table below indicates Zona's estimates of LL's earnings potential if it came under Lavender's management (in millions of dollars). The interest expense listed here includes the interest: (1) on LL's existing debt, which is S million at a rate of 9%, and (2) on new debt expected to be issued over time to help finance expansion within the new "L division," the code name given to the target firm. If acquired, LL will face a 35% tax rate. Security analysts estimate LL's beta to be X. The acquisition would not change Lyons capital structure, which is 22% debt. Zona realizes that Lyons Lighting's business plan also requires certain levels of operating capital and that the annual investment could be significant. The required levels of total net operating capital are listed in the table. Zona estimates the risk-fra rate to be 7.2% and the market risk premium to be 4.75%. He also estimates that free cash flows after 2020 will grow at a constant rate of Z%. Group 1 Group 2 Group 3 Group 4 Group 5 Group 6 Group 7 LL's debt 63 68 72 77 51 58 55 LL's beta (X) 1.18 1.22 1.35 1.38 1.07 1.15 1.12 Free Cash 6.25 6.5 6.25 6.5 6.25 6.5 Flow growth Rate (Z) 6 Following are projections for sales and other items. 2015 2016 2017 2018 2019 2020 Net Sales $60.00 $90.00 $112.50 $127.50 $139.70 Cost of Goods Sold 36.00 54.00 67.50 76.50 83.80 Selling /Administrative 4.80 6.10 7.60 9.20 11.30 Expense Interest Expense 5.00 6.50 6.50 7.00 8.16 Total $150.00 150.00 157.50 163.50 168.00 173.00 Net Operating Capital Lavender's management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Lavender's board. h. How would the analysis be different if Lavender intended to recapitalize Ll with 40% debt costing 10% at the end of 4 years? This amounts to $221.6 million in debt as of the end of 2019. Mergers and Acquisitions Lavender Repair Company, a regional hardware chain that specializes in "do it yourself" materials and equipment rentals, is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition. Doug Zona, Lavender's treasurer, and your boss, has been asked to place a value on a potential target, Lyons Lighting (LL), a chain that operates in several adjacent states, and he has enlisted your help. The table below indicates Zona's estimates of LL's earnings potential if it came under Lavender's management (in millions of dollars). The interest expense listed here includes the interest: (1) on LL's existing debt, which is S million at a rate of 9%, and (2) on new debt expected to be issued over time to help finance expansion within the new "L division," the code name given to the target firm. If acquired, LL will face a 35% tax rate. Security analysts estimate LL's beta to be X. The acquisition would not change Lyons capital structure, which is 22% debt. Zona realizes that Lyons Lighting's business plan also requires certain levels of operating capital and that the annual investment could be significant. The required levels of total net operating capital are listed in the table. Zona estimates the risk-fra rate to be 7.2% and the market risk premium to be 4.75%. He also estimates that free cash flows after 2020 will grow at a constant rate of Z%. Group 1 Group 2 Group 3 Group 4 Group 5 Group 6 Group 7 LL's debt 63 68 72 77 51 58 55 LL's beta (X) 1.18 1.22 1.35 1.38 1.07 1.15 1.12 Free Cash 6.25 6.5 6.25 6.5 6.25 6.5 Flow growth Rate (Z) 6 Following are projections for sales and other items. 2015 2016 2017 2018 2019 2020 Net Sales $60.00 $90.00 $112.50 $127.50 $139.70 Cost of Goods Sold 36.00 54.00 67.50 76.50 83.80 Selling /Administrative 4.80 6.10 7.60 9.20 11.30 Expense Interest Expense 5.00 6.50 6.50 7.00 8.16 Total $150.00 150.00 157.50 163.50 168.00 173.00 Net Operating Capital Lavender's management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Lavender's board. h. How would the analysis be different if Lavender intended to recapitalize Ll with 40% debt costing 10% at the end of 4 years? This amounts to $221.6 million in debt as of the end of 2019