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Grand Canyon FIN650 module 8 chapter 21 problem




Question;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?


Paper#49114 | Written in 18-Jul-2015

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