Chapter 20 3 Valuation Merger Department Stores Inc Asking

51.

Valuation of a Merger Windows N Such, Inc., is asking a price of $195 million to be

purchased by Curtain Rods Corp. The two firms currently have cumulative total cash flows

of $15 million which are growing at 1 percent annually. Managers estimate that because of

synergies the merged firm’s cash flows will increase by an additional 3 percent for the first

four years following the merger. After the first four years cash flows will grow at a rate of 2

percent. The WACC for the merged firms is 10 percent. Calculate the NPV of the merger.

Should Curtain Rods Corporation agree to acquire Windows N Such, Inc., for the asking

price of $195 million?

52.

Valuation of a Merger Department Stores, Inc., is asking a price of $25 million to be

purchased by Discount Stores Corp. The two firms currently have cumulative total cash

flows of $2 million which are growing at 2.5 percent annually. Managers estimate that

because of synergies the merged firm’s cash flows will increase by an additional 5 percent

for the first four years following the merger. After the first four years cash flows will grow

at a rate of 4.5 percent. The WACC for the merged firms is 13 percent. Calculate the NPV

of the merger. Should Discount Stores Corporation agree to acquire Department Stores,

Inc., for the asking price of $25 million?

53.

Valuation of a Merger You own stock in Carpet City, Inc., which has just made a bid of

$165 million to purchase Tile Corporation. The two firms currently have cumulative total

cash flows of $25 million which are growing at 2 percent annually. Managers estimate that

because of synergies the merged firm’s cash flows will increase by an additional 4 percent

for the first three years following the merger. After the first three years cash flows will

grow at a rate of 3 percent. The merged firms are expected to have a beta = 1.75, the risk–

free rate is 5.5 percent, and the market risk premium is currently 7.5 percent. Calculate the

NPV of the merger. Will you vote in favor of the merger?

54.

Calculation of Bankruptcy Probability Suppose a linear probability model you have

developed finds there are two factors influencing the past bankruptcy behavior of firms:

the debt ratio and the profit margin. Based on past bankruptcy experience, the linear

probability model is estimated as:

PDi = 0.18 (debt ratio) + 0.35 (profit margin)

You know a particular firm has a debt ratio of 35 percent and a probability of default of 8

percent. Calculate the firm’s profit margin.

55.

Calculation of Bankruptcy Probability Suppose a linear probability model you have

developed finds there are two factors influencing the past bankruptcy behavior of firms:

the debt ratio and the profit margin. Based on past bankruptcy experience, the linear

probability model is estimated as:

PDi = 0.20 (debt ratio) + 0.50 (profit margin)

You know a particular firm has a debt ratio of 60 percent and a probability of default of 15

percent. Calculate the firm’s profit margin.

56.

Calculation of Bankruptcy Probability A linear probability model you have developed

finds there are two factors influencing the past bankruptcy behavior of firms: the equity

multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the

linear probability model is estimated as:

PDi = 0.04 (equity multiplier) + 0.01 (total asset turnover)

A firm has an equity multiplier of 1.5 times and a probability of default of 7 percent.

Calculate the firm’s total asset turnover ratio.

57.

Calculation of Bankruptcy Probability A linear probability model you have developed

finds there are two factors influencing the past bankruptcy behavior of firms: the equity

multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the

linear probability model is estimated as:

PDi = 0.05 (equity multiplier) + 0.02 (total asset turnover)

A firm has an equity multiplier of 1.9 times and a probability of default of 10 percent.

Calculate the firm’s total asset turnover ratio.

58.

Economies of Scope A survey of a local market provided the following average cost data:

Johnson Construction Corp. (JCC) has assets of $4 million and an average cost of 10

percent; Anderson Architects (AA) has assets of $5 million and an average cost of 20

percent; Cole Home Builders (CHB) has assets of $5 million and an average cost of 15

percent. For each firm, average costs are measured as a proportion of assets. JCC is

planning to acquire AA and CHB with the expectation of reducing overall average costs by

eliminating the duplication of services.

What should be the average cost after the acquisition for JCC to justify this merger?

59.

Economies of Scope A survey of a local market provided the following average cost data:

Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15

percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20

percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17

percent. For each firm, average costs are measured as a proportion of assets. JCC is

planning to acquire AA and CHB with the expectation of reducing overall average costs by

eliminating the duplication of services.

What should be the average cost after the acquisition for JCC to justify this merger?

60.

Economies of Scope A survey of a local market provided the following average cost data:

Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15

percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20

percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17

percent. For each firm, average costs are measured as a proportion of assets. JCC is

planning to acquire AA and CHB with the expectation of reducing overall average costs by

eliminating the duplication of services. If JCC plans to reduce operating costs by $300,000

after the merger, what will the average cost be for the new firm?

61.

Economies of Scope A survey of a national market provided the following average cost

data: Jackson County Construction (JCC) has assets of $2 million and an average cost of

30 percent; Arkansas Architects (AA) has assets of $1.5 million and an average cost of 20

percent; Colorado Home Builders (CHB) has assets of $500,000 and an average cost of 10

percent. For each firm, average costs are measured as a proportion of assets. JCC is

planning to acquire AA and CHB with the expectation of reducing overall average costs by

eliminating the duplication of services. If JCC plans to reduce operating costs by $200,000

after the merger, what will the average cost be for the new firm?

62.

Valuation of a Merger The managers of BSW Inc. have been approached by EAG Corp. for

a possible merger. EAG Corp. is asking a price of $20.5 million to be purchased by BSW

Inc. The two firms currently have cumulative total cash flows of $1 million that are growing

at 3 percent annually. Managers of EAG estimate that because of synergies the merged

firm’s cash flows will increase by an additional 4 percent for the first three years following

the merger. After the first three years, managers of EAG have estimated that cash flows

will grow at a rate of 2 percent. The WACC for the merged firms is 8 percent. Managers of

BSW Inc. agree that cash flows should grow at an additional 4 percent for the first three

years, but are unsure of the long-term growth rate in cash flows estimated by EAG.

Calculate the minimum growth rate needed after the first three years such that BSW Inc.

would see this merger as a positive NPV project.

63.

Valuation of a Merger The managers of BSW Inc. have been approached by EAG Corp. for

a possible merger. EAG Corp. is asking a price of $50 million to be purchased by BSW Inc.

The two firms currently have cumulative total cash flows of $2.5 million that are growing at

2 percent annually. Managers of EAG estimate that because of synergies the merged

firm’s cash flows will increase by an additional 5 percent for the first three years following

the merger. After the first three years, managers of EAG have estimated that cash flows

will grow at a rate of 2 percent. The WACC for the merged firms is 12 percent. Managers

of BSW Inc. agree that cash flows should grow at an additional 5 percent for the first three

years, but are unsure of the long-term growth rate in cash flows estimated by EAG.

Calculate the minimum growth rate needed after the first three years such that BSW Inc.

would see this merger as a positive NPV project.

64.

Calculating the Probability of Bankruptcy A linear probability model you have developed

finds there are two factors influencing the past bankruptcy behavior of firms: the debt–to–

equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the

linear probability model is estimated as:

PDi = 0.45 (debt/equity) + 0.01 (sales/total assets)

A firm you are thinking of lending to has a sales–to–assets ratio of 1.9 and its expected

probability of default, or bankruptcy, is estimated to be 7 percent. Calculate the firm’s debt

ratio.

65.

Calculating the Probability of Bankruptcy A linear probability model you have developed

finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to–

equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the

linear probability model is estimated as:

PDi = 0.60 (debt/equity) + 0.02 (sales/total assets)

A firm you are thinking of lending to has a sales-to–assets ratio of 1.75 and its expected

probability of default, or bankruptcy, is estimated to be 8.1 percent. Calculate the firm’s

debt ratio.