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The cash flows for the first four years after the merger are:
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.
