Finance Chapter 20 3 Valuation Merger Windows Such Inc Asking Price 195 Million Purchased Curtain

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.