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Financial Management | 16th Edition

Chapter 22, Problem 7SP

Wansley Portal Inc., a large Internet service provider, is evaluating the possible acquisition of Alabama Connections Company (ACC), a regional Internet service provider. Wansleys analysts project the following post-merger data for ACC (in thousands of dollars):

If the acquisition is made, it will occur on January 1, 2020. All cash flows shown in the income statements are assumed to occur at the end of the year. ACC currently has a capital structure of 30% debt, which costs 9%, but Wansley would increase that over time to 40%, costing 10%, if the acquisition were made. ACC, if independent, would pay taxes at 25%, and its income would be taxed at 25% if it were consolidated. ACCs current market-determined beta is 1.4. The cost of goods sold, which includes depreciation, is expected to be 65% of sales. Required gross investment in operating capital is approximately equal to the depreciation charged, so there will be no investment in net operating capital. The risk-free rate is 7%, and the market risk premium is 6.5%. Wansley currently has $400,000 in debt outstanding. Use the compressed APV model to answer the following questions.

a. What is the unlevered cost of equity?

b. What are the horizon value of the tax shields and the horizon value of the unlevered operations? What are the value of ACCs operations and the value of ACCs equity to Wansleys shareholders?

\begin{tabular}{lrrrrr} & 2020 & 2021 & 2022 & 2023 & 2024 \\ \hline Net sales & $500 & $600 & $700 & $760 & $806 \\ Selling and administrative expense & 60 & 70 & 80 & 90 & 96 \\ Interest & 30 & 40 & 45 & 60 & 74 \end{tabular}

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