The following represents the target's accounting data you've estimated for the years XXXXXXXXXXFall...

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The following represents the target's accounting data you've estimated for the years XXXXXXXXXX
Fall 2020    Q5    Dr. de la To
e
Fall 2020        Page | 2
The following represents the target’s accounting data you have estimated for the years XXXXXXXXXXAssume that all of these numbers are end-of-year data (i.e. today is January 1st, 2020 and the revenues, etc. are at the end of 2020, 2021).
In addition, you have the following information for the target and the acquiring firm.

    2020
    2021
    Revenues
    $100,000,000
    $120,000,000
    Cost of Goods Sold
    $30,000,000
    $55,000,000
    Depreciation
    $10,000,000
    $15,000,000
    A&G
    $8,000,000
    $11,000,000
    Interest
    $4,000,000
    $5,000,000
    Retained Earnings
    $2,000,000
    $3,000,000
    Target
    Acquiring Firm
    L = 1.8
    Cap Structure: Debt = 70%
    Taxes = 40%
    Taxes = 35%
    Cap Structure: Debt = 20%

    # of Shares Outstanding = 4,500,000
    Other Information
    Cu
ent Price per Share = $30
    T-bond rate = 5%
    Est. Future Growth Rate = 4%
    Mkt Risk Premium = 6%
(15 points) Calculate the appropriate cashflows.
(10 points) Calculate the appropriate discount rate for the acquiring firm based on the value of the target.
(5 points) Why is this rate so high?
(15 points) Calculate the target firm value.
(5 points) What would be a reasonable offer (i.e. $/share) for the target.
(5 points) Explain why the cost of equity is used as the discount rate.
(5 points) Explain why the retained earnings are subtracted to a
ive at the appropriate cash flow.
(10 points) Explain why we de-lever and re-lever the L.
(5 points) What tax rate do we use to derive the cash flows? Why?
(10 points) List at least three weaknesses of the analysis.
⓫ (5 points) Why is the covariance of debt and the market equal to zero? What impact does this have on beta?
2.    (10 points) Explain how having only 50% of M&As succeed a means of justifying the efficient market hypothesis.
Fall 2020    1    MBA 670
Quiz No. 5        MBA 670

mba-q5-fall-2020-u3m2qyoq.docx

Harshit · Accepted Answer

Solution to Question 5
1. Appropriate cash flows:									
	 
	2020
	2021
	Revenue
	$100,000,000 
	$120,000,000 
	Less: 
	 
	 
	Cost of Goods Sold
	$30,000,000 
	$55,000,000 
	Depreciation
	$10,000,000 
	$15,000,000 
	A&G
	$8,000,000 
	$11,000,000 
	Interest
	$4,000,000 
	$5,000,000 
	Profit before tax
	$48,000,000 
	$34,000,000 
	Less:  Tax @35%
	$16,800,000 
	$11,900,000 
	Profit after tax
	$31,200,000 
	$22,100,000 
	Add: Depreciation
	$10,000,000 
	$15,000,000 
	Less: Retained earning
	$2,000,000 
	$3,000,000 
	Cash Flows
	$39,200,000 
	$34,100,000 
																																																											
2. Calculation of the appropriate discount rate are
Appropriate Discount rate is cost of equity. 
By CAPM, cost of equity will be:
Ke	= Rf + (Rm-Rf)
	 (Risk Premium)*
	
	
	
	Therefore, discount rate to be used is 15.8%	
3. Discount rate is high due to high beta (). Beta represents the sensitivity of firm with respect to market. High sensitivity means high risk. The higher the risk higher will be risk premium. Here the Beta of target firm is 1.8 which when multiplied with risk premium resulted in high discount rate.
4. Value of target firm:
	Initial Phase
	
	
	
	
	
	
	
	
	
	 
	2020
	2021
	
	
	Revenue
	$100,000,000 
	$120,000,000 
	
	
	Less: 
	 
	 
	
	
	Cost of Goods Sold
	$30,000,000 
	$55,000,000 
	
	
	Depreciation
	$10,000,000 
	$15,000,000 
	
	
	A&G
	$8,000,000 
	$11,000,000 
	
	
	Interest
	$4,000,000 
	$5,000,000 
	
	
	Profit before tax
	$48,000,000 
	$34,000,000 
	
	
	Less:  Tax @35%
	$16,800,000 
	$11,900,000 
	
	
	Profit after tax
	$31,200,000 
	$22,100,000 
	
	
	Add: Depreciation
	$10,000,000 
	$15,000,000 
	
	
	Less: Reatined earning
	$2,000,000 
	$3,000,000 
	
	
	Cash Flows
	$39,200,000 
	$34,100,000 
	
	
	Discounting factor @ 15.8%
	                  0.8636 
	                  0.

The following represents the target's accounting data you've estimated for the years XXXXXXXXXX Fall 2020 Q5 Dr. de la Torre Fall 2020 Page | 2 The following represents the target’s accounting data...

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