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) 2017 $600 70 40 2018 $700 80 45 2019 Net sales Selling and administrative expense Interest 2016 $500 60 30 2020 $760$806 96 74 90 60 If the acquisition is made, it will occur on January 1, 2016. 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 30 percent, but its income would be taxed at 35 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, but it could vary somewhat. 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 Tax rate of ACC before the merger Tax rate after merger Cost of goods sold as a % of sales Debt ratio (percent financed with debt) before the merger Cost of debt before merger Debt ratio (percent financed with debt) after the merger Cost of debt after merger Beta of ACC Risk-free rate Market risk premium Terminal growth rate of free cash flow Pre-merger debt (in thousands) 30% 35% 65% 30% 9% 40% 10% 1.40 7% 6.5% 6.0% $ 400 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 2016 2017 2018 2019 2020 Sales Cost of Goods Sold (including depreciation) Gross Profit Selling and admin. Costs EBIT Interest EBT Taxes Net Income EBIT NOPAT Investment in net operating capital FCF 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