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Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer...

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Finance

Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP). Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:

Year 1 2 3 4

Free cash flow $1 $3 $3 $7

Unlevered horizon value on year 4 -75

Tax shield 1 1 2 3

Horizon value of tax shield on year 4- 32

Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. Using the compressed adjusted present value approach, what is the value of SGP to Raymond?

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