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Solution
Chapter: 22
Problem: 7
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):
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Investment in net operating capital 0 0 0 0 0
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2017 2018 2019 2020 2021
Interest 30.0 40.0 45.0 60.0 74.0
Tax shield 10.5 14.0 15.8 21.0 25.9
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To calculate the value of the tax shields add the horizon value of the tax shields to the 2021 tax shield
to get the total tax shield cash flow in 2021. In the other years the total TS cash flow is just the annual TS
Then find the NPV of this stream of tax shields at the unlevered cost of equity.
2017 2018 2019 2020 2021
Total TS Cash Flows 10.5 14.0 15.8 21.0 $370.37
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HVUL 2021 = FCF2021 * (1+g) / (rsU –g)
HVUL 2021 = $120.97 * 1.060 / 13.97% – 6.0%
HVUL 2021 = $128.22 / 0.080
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2017 2018 2019 2020 2021
Sales $500.0 $600.0 $700.0 $760.0 $806.0
Cost of Goods Sold (incl. depreciation) 325.0 390.0 455.0 494.0 523.9
Gross Profit 175.0 210.0 245.0 266.0 282.1
Selling/admin. costs 60.0 70.0 80.0 90.0 96.0
EBIT 115.0 140.0 165.0 176.0 186.1
Interest 30.0 40.0 45.0 60.0 74.0
EBT 85.0 100.0 120.0 116.0 112.1
Taxes 29.8 35.0 42.0 40.6 39.2
Net Income $55.3 $65.0 $78.0 $75.4 $72.9
EBIT 115.0 140.0 165.0 176.0 186.1
NOPAT 74.8 91.0 107.3 114.4 121.0
We must determine the tax shields.
From this point, we can derive horizon value from the basic DCF framework.
The tax shield is the interest multiplied by the post-merger tax rate.
HVTS 2020 =TS2021 * (1+g) / (rsU –g)
HVTS 2020 = $25.90 * 1.060 / 13.97% – 6.0%
HVTS 2020 = $27.45 / 7.97%
HVTS 2020 = $344.47
NPV of TS Cash Flows $235.69 This is the value of all of the tax shields.
To calculate the unlevered value of operations you need the unlevered horizon value and the
the annual free cash flows.
To calculate the unlevered horizon value, we just need the free cash flow for 2021
HVUL 2021 = $1,608.82
To calculate the unlevered value of operations, add the unlevered horizon value to the free cash flow
in 2021 to get the total unlevered cash flow in 2021. In the other years the unlevered cash flow is
* In this scenario, we state that investment in net operating capital is zero. This arises from the fact that the only needed
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just the annual free cash flow. The unlevered value of operations is the NPV of the unlevered
cash flows at the unlevered cost of equity.
Year 2017 2018 2019 2020 2021
Total unlevered CFs $74.8 $91.0 $107.3 $114.4 $1,729.8
NPV of unlevered CFs $1,175.5 This is the unlevered value of operations
The value of operations is the value of the interest tax shields plus the unlevered value of operations
VTS + Vunlevered
Vops = $235.69 + $1,175.48
Vops = $1,411.17
Vops = $1,411.17
Debt = $400.00
Equity = $1,011.17
To find the value of ACC to Wansley’s shareholders take the value of operations, add in any non-operating
assets (there are non for ACC) and subtract off the debt.
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J
7/16/2015
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):
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
The unlevered cost of equity should be used to discount the FCFs, tax shields and horizon value.
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?
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* In this scenario, we state that investment in net operating capital is zero. This arises from the fact that the only needed