Grand Canyon FIN650 module 8 chapter 21 problem
Question # 00020151
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Updated on: 07/18/2014 01:39 AM Due on: 08/21/2014
| Marston Marble Corporation is considering a merger with the Conroy Concrete | ||||||
| Company. Conroy is a publicly traded company, and its beta is 1.30. Conroy has | ||||||
| been barely profitable, so it has paid an average of only 20% in taxes during the last | ||||||
| several years. In addition, it uses little debt; its target ratio is just 25%, with the cost | ||||||
| of debt 9%. | ||||||
| If the acquisition were made, Marston would operate Conroy as a separate, wholly | ||||||
| owned subsidiary. Marston would pay taxes on a consolidated basis, and the tax rate | ||||||
| would therefore increase to 35%. Marston also would increase the debt capitalization | ||||||
| in the Conroy subsidiary to wd = 40%, for a total of $22.27 million in debt by the | ||||||
| end of Year 4, and pay 9.5% on the debt. Marston’s acquisition department estimates | ||||||
| that Conroy, if acquired, would generate the following free cash flows and interest | ||||||
| expenses (in millions of dollars) in Years 1–5: | ||||||
| Year | Free Cash Flow | Interest Expense | ||||
| 1 | $1.30 | $1.20 | ||||
| 2 | 1.50 | 1.7 | ||||
| 3 | 1.75 | 2.8 | ||||
| 4 | 2.00 | 2.1 | ||||
| 5 | 2.12 | ? | ||||
| In Year 5, Conroy’s interest expense would be based on its beginning-of-year (that is, | ||||||
| the end-of-Year-4) debt, and in subsequent years both interest expense and free cash | ||||||
| flows are projected to grow at a rate of 6%. | ||||||
| These cash flows include all acquisition effects. Marston’s cost of equity is 10.5%, | ||||||
| its beta is 1.0, and its cost of debt is 9.5%. The risk-free rate is 6%, and the market | ||||||
| risk premium is 4.5%. | ||||||
| a. What is the value of Conroy’s unlevered operations, and what is the value of | ||||||
| Conroy’s tax shields under the proposed merger and financing arrangements? | ||||||
| b. What is the dollar value of Conroy’s operations? If Conroy has $10 million in | ||||||
| debt outstanding, how much would Marston be willing to pay for Conroy? |
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Solution: Grand Canyon FIN650 module 8 chapter 21 problem