VolWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Bulldog Cable Company (BCC), a regional cable company. VolWorlds analysts project the following post-merger data for BCC (in thousands of dollars, with a year end of December 31):

201420152016201720182019

Net sales 450 518 555 600 643

Selling and administrative expense 45 53 60 68 73

Interest 40 45 47 52 54

Total net operating capital 800 850 930 1,005 1,075 1,150

Tax rate after merger: 35%

Cost of goods sold as a percent of sales: 65%

BCCs pre-merger beta: 1.40

Risk-free rate: 6%

Market risk premium: 4%

Terminal growth rate of free cash flows: 7%

If the acquisition is made, it will occur on January 1, 2015. All cash flows shown in the income statements are assumed to occur at the end of the year. BCC currently has a capital structure of 40% debt, which costs 10%, but over the next 4 years VolWorld would increase that to 50%, and the target capital structure would be reached by the start of 2019. BCC, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. BCCs current market-determined beta is 1.4. The cost of goods sold is expected to be 65% of sales.

a. What is the unlevered cost of equity for BCC?

b. What are the free cash flows and interest tax shields for the first five years?

c. What is BCCs horizon value of interest tax shields and unlevered horizon value?

d. What is the value of BCCs equity to VolWorlds shareholders if BCC has $300,000 in debt outstanding now?