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INTEROFFICE MEMORANDUM TO: Students FROM: CFO, SNAP Camera Inc. SU B J E C T : Valuing a potential acquisition DATE: March 2019 SNAP Camera, Inc. wants to acquire a company called Color-Me-Red. Your assignment is to value Color-Me-Red. Color-Me-Red sales revenues are projected to be $300 million in year 1, $400 million in year 2, $900 million in year 3, $1,200 million in year 4, and $ 1,400 in year 5. Costs of goods sold (COGS) are a constant 65% of sales revenues. In year 1, Color-Me-Red selling, general and administrative (SG&A) expenses are projected to be $100 million and are expected stay constant forever. No changes in working capital are expected. Assume that Color-Me-Red's free cash ows grow at a constant rate of g=2% after year 5 (i.e., free cash ows in year 6 = free cash ows in year 5 "' (1 + g). Assume Color-Me-Red's assets are depreciated using straight-line depreciation over 50 years. Capital expenditures in year t will be depreciated for the rst time in year t+ 1. Existing assets have a current (t: 0) book value of $100 million and have a remaining life of 25 years. Capital expenditures over the next five years are expected to be $110 million in year 1, $100 million in year 2, $70 million in year 3, $20 million in year 4, and $10 million in year 5. Salvage values are zero. The acquisition is expected to generate synergies with a present value of $480 million. Five comparable publicly traded rms to Color-Me-Red have been identified: Indi-Glo Color Creative Color M 2 Too! Rainbow- Ine. Rama ----I- W mum Ratio For your analytical purposes, SNAP Camera and Color-Me-Red both finance 40% of their assets with debt and the debt-equity ratio remains constant over time. Other assumptions you should work with are: (l) the risk-free rate is 3.35%, (2) the market risk premium is 5%, {3) the marginal tax rate for both SNAP Camera and Color -Me-Red is 20%, {4) there are 200 million shares of Color-Me-Red outstanding, and (5) all cash flows occur at the end of the year. Answer the following questions, and if necessary, carefully state any additional assumptions that you make in order to solve the questions: Question 1: Calculate WACC for Color-Me-Red. A. Calculate the asset betas for each of the comparable firms; assuming debt is riskless. B. Determine the average asset beta of the comparable firms. C. Calculate the underlying riskiness of the cash flows (Bwave), assuming the average asset beta of the comparable firms is your best estimate of the asset beta for Color-Me-Red and assuming the debt of Color-Me-Red is risk-free. D. Calculate the WACC.Question 2: Calculate Depreciation for Color-Me-Red. A. Determine the annual depreciation of existing assets (i.e., assets in place at t=0). B. For each of the next five years (t=1, t=2, t=3, t=4, t=5), determine the additional depreciation from the additional capital expenditures that are made over the next five years: C. For each of the next five years (t=1, t=2, t=3, t=4, t=5), determine the total annual depreciation
