Item4
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Item 4
A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target company’s equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the target’s cash flows and sell it for 12 times free cash flow in year five. Projected free cash flows and selling price are as follows.
Year($ millions)12345Free cash flows$ 35$ 50$ 55$ 60$ 60Selling price $ 720Total free cash flows$ 35$ 50$ 55$ 60$ 780
To finance the purchase, the investors have negotiated a $500 million, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition.
Selected Additional InformationTax rate40percentRisk-free interest rate3percentMarket risk premium5percent
Estimate the target firm’s asset beta.
Note: Round your answer to 2 decimal places.
Estimate the target’s unlevered, or all-equity, cost of capital (KA).(KA).
Note: Round your answer to 1 decimal place.
Estimate the target’s all-equity present value.
Note: Enter your answer in millions rounded to 2 decimal places.
Estimate the present value of the interest tax shields on the acquisition debt discounted at KAKA .