11/23/2018
Projections 2019 2020 2021 2022 2023 2024
Net sales $150 $170 $186 $200 $212
Cost of goods sold $116 $128 $135 $148 $160
aDebt is added on the first day of the year, so the 2019 debt is LL’s debt prior to the acquisition.
Other data:
LL shares outstanding
10 million
LL stock price
$12.00
LL beta 1.250
2019 2020 2021 2022 2023 2024
Net sales $150 $170 $186 $200 $212
Cost of goods sold $116 $128 $135 $148 $160
Selling/administrative expense $22 $26 $27 $28 $32
Chapter 22. Mini Case for Mergers and Corporate Control
d. Why can’t we estimate LL’s value to Hager’s by discount the FCFs at the WACC? What method is appropriate? Use the projections
and other data to determine the LL division’s free cash flows and interest tax savings for 2020 through 2024. Notice that the LL
division’s sales are expected to grow rapidly during the first years before leveling off at a sustainable long-term growth rate.
Hager’s management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform
the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Hager’s
board.
a. Several reasons have been proposed to justify mergers. Among the more prominent are (1) synergy, (2) tax considerations, (3)
breakup value, (4) risk reduction through diversification, (4) purchase of assets at below-replacement cost, and (5) managerial
incentives. In general, which of the reasons are economically justifiable? Which are not? See PowerPoint show.
acquisition. The forecasted interest expense includes the combined interest on LL’s existing debt and on new debt. After 2024, all items are
expected to grow at a constant 6% rate.
LL has 20 million shares of stock trading at $12 per share. Security analysts estimate LL’s beta to be 1.25. The risk-free rate is 5.5% and the
will have an 8% rate. LL has a 25% federal-plus-state tax rate which will not change due to the acquisition.
Hager’s Home Repair Company, a regional hardware chain, which specializes in “do-it-yourself” materials and equipment rentals, is considering
an acquisition of Lyon Lighting (LL). Doug Zona, Hager’s treasurer and your boss, has been asked to place a value on the target and he has
enlisted your help.
Unlevered Horizon Value
Unlevered Horizon Value = HVU = (2024 Free Cash Flow)(1+g)
Unlevered Value
When debt levels are changing rapidly, as they do with many mergers, it is difficult to apply the corporate value model or standard capital
budgeting techniques to merger valuation because the discount rate changes as the debt level changes. Instead, the APV method is easier to
apply.
rsU – g
e. What is the appropriate discount rate that should be used to discount the FCFs and interest tax savings? Calculate this rate.
f. What is the estimated unlevered horizon value? What is the current unlevered value operating value? What is the horizon value of
the interest tax savings? What is the current value of the interest tax savings? What is the current total value of the acquisition to
Hager’s shareholders? Suppose another firm were evaluating Lyon Lighting as an acquisition candidate. Would they obtain the same
value? Explain.
Tax Shield Horizon Value
Tax Shield Horizon Value = (2024 Tax Shield)(1+g)
TS. Horizon Value =
$28.620 million
Tax Shield Value
Total Value of Operations, Value of Equity, and Intrinsic Stock Price
Vops = VTax shield + VUnlevered = $190.254 million
k. What are the major types of divestitures? What motivates firms to divest assets? See PowerPoint show.
l. What are holding companies? What are their advantages and disadvantages? See PowerPoint show.
j. What merger-related activities are undertaken by investment bankers? See PowerPoint show.
rsU – g
i. What method is used to account for mergers? See PowerPoint show.
g. Should Hager’s make an offer for Lyon Lighting? If so, how much should it offer per share?
h. There has been considerable research undertaken to determine whether mergers really create value, and, if so, how this value is
shared between the parties involved. What are the results of this research? See PowerPoint show.