Wansley Portal Inc., a large Internet service provider, is evaluating the possible acquisition of Alabama Connections Company (ACC), a regional Internet service provider. Wansley's analysts project the following post merger data for ACC (in thousands of dollars): If the acquisition is made, it will occur on January 1, 2021. All cash flows shown in the income statements are assumed to occur at the end of the year. ACC currently has a capital structure of 30 percent debt, which costs 9 percent, but Wansley would increase that to 40 percent debt, costing 10 percent if the acquisition were made. ACC, if independent, would pay taxes at 25 percent, and its income would be taxed at 25 percent if it werre consolidated. ACC's current market-determined beta is 1.40 . The cost of goods sold is expected to be 65 percent of sales. Gross investment in operating assets is expected to be equal to depreciation--replacing worn out equipment, so net investment in operating assets will be zero. The risk-free rate is 7 percent, and the market risk premium is 6.5 percent. Wansley currently has $400,000 in debt outstanding. Use the compressed APV model to answer the following questions. The unlevered cost of equity should be used to discount the FCFs, tax shields and horizon value. Step 1: Find the levered cost of equity at old capital structure. Step 2: Find the unlevered cost of equity. b. What is the horizon value of the tax shields and the unlevered operations? What is the value of ACC's operations and the value of ACC's equity to Wansley's shareholders? Before we can proceed with this problem, we must generate pro forma income statements for ACC's operations after the proposed merger so we can calculate free cash flow and interest tax shields. * In this scenario, we state that investment in net operating capital is zero. This arises from the fact that the only needed investments are those needed to replace worn out capital, and that they equal depreciation. We must determine the tax shields. From this point, we can derive horizon value from the basic DCF framework. The tax shield is the interest multiplied by the post-merger tax rate. To calculate the value of the tax shields add the horizon value of the tax shields to the 2025 tax shield to get the total tax shield cash flow in 2025. In the other years the total TS cash flow is just the annual TS Then find the NPV of this stream of tax shields at the unlevered cost of equity. \begin{tabular}{|l|l|l|l|l|l|} \hline & 2021 & 2022 & 2023 & 2024 & 2025 \\ \cline { 2 - 5 } & & & & \end{tabular} NPV of TS Cash Flows This is the value of all of the tax shields. To calculate the unlevered value of operations you need the unlevered horizon value and the the annual free cash flows. To calculate the unlevered horizon value, we just need the free cash flow for 2025 g) To calculate the unlevered value of operations, add the unlevered horizon value to the free cash flow in 2025 to get the total unlevered cash flow in 2025. In the other years the unlevered cash flow is just the annual free cash flow. The unlevered value of operations is the NPV of the unlevered cash flows at the unlevered cost of equity. \begin{tabular}{|l|lllll|} \hline Year & 2021 & 2022 & 2023 & 2024 & 2025 \\ \cline { 2 - 5 } Total unlevered CFs & & & & & \end{tabular} NPV of unlevered CFs This is the unlevered value of operations The value of operations is the value of the interest tax shields plus the unlevered value of operations \begin{tabular}{|l|l|l|l|l|} 4 & & VTs & + & Vunlevered \\ 5 & Vops & & \\ 6 & V & \\ \hline & Vops & & \\ 7 & & & \\ 8 & & & \end{tabular} 9 To find the value of ACC to Wansley's shareholders take the value of operations, add in any nonoperating assets (there are non for ACC) and subtract off the debt. 234VopsDebtEquity==