Shawnee Corp is interested in acquiring Jackson. Jackson has 100 million shares outstanding and a target capital structure consisting of 35% debt and 65% equity.
Jackson's debt interest rate is 10%. Assume that the risk-free rate of interest is 2 percent and the market risk premium is 12%.
Jackson's free cash flow (FCF0) is $75 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1.3.
Jackson has $25 million in debt. The tax rate for both companies is 35 percent.
a. Calculate the required rate of return on equity using CAPM equation.
b. Calculate weighted average cost of capital (WACC).
c. Calculate the value of operations, using equation: Vops = FCF0(1+g)/WACC - g)
d. Calculate the value of the company's equity, using equation: Vs = Vops - debt
e. Calculate the current value of the company's stock, using equation:
Price per share = Vs/shares outstanding