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MERGER ANALYSIS TransWorld Communications Inc., a largetelecommunications company,
is evaluating the possible acquisition of Georgia Cable Company(GCC), a regional
cable company. TransWorld’s analysts project the followingpost-merger data for GCC (in
thousands of dollars):
                                                     2015 2016 2017 2018
Net sales                                   $450 $518 $555 $600
Selling and administrative expense   45     53      60     68
Interest                                              18     21      24 27
Tax rate after merger 35%
Cost of goods sold as a percent of sales 65%
Beta after merger 1.50
Risk-free rate 8%
Market risk premium 4%
Continuing growth rate of cash flow available to
TransWorld 7%
If the acquisition is made, it will occur on January 1, 2015. Allcash flows shown in the
income statements are assumed to occur at the end of the year. GCCcurrently has a
capital structure of 40% debt, but Trans World would increase thatto 50% if the
acquisition were made. GCC, if independent, would pay taxes at 20%;but its income
would be taxed at 35% if it were consolidated. GCC’s currentmarket-determined beta
is 1.40, and its investment bankers think that its beta would riseto 1.50 if the debt ratio
were increased to 50%. The cost of goods sold is expected to be 65%of sales, but it
could vary somewhat. Depreciation-generated funds would be used toreplace wornout
equipment, so they would not be available to TransWorld’sshareholders. The riskfree
rate is 8%, and the market risk premium is 4%.
a. What is the appropriate discount rate for valuing theacquisition?
b. What is the continuing value?
c. What is the value of GCC to TransWorld?