FIRM VALUATION Last year firm A generated $10,000 of FCF. FCF is not expected to

FIRM VALUATION
Last year firm A generated $10,000 of FCF. FCF is not expected to grow, but will be earned in
perpetuity. Firm A is entirely financed with equity, and its beta is 1.4. The risk-free rate is 2%,
the market risk premium is 5%, and the tax rate is 25%. Firm A has 4,000 shares outstanding and
$15,000 of excess cash on hand.
a) What is the per share value of Firm A? (5 marks)
b) Consider another company, firm B. Firm B is identical to firm A in every way except financing.
Firm B has $40,000 of perpetual debt outstanding with a cost of debt of 6%. What is the APV
Enterprise Value of firm B? Assume the world conforms to M&M with taxes and the market
value of debt equals the face value of debt. (3 marks)
c) What is the D/E ratio of firm B? Assume that market values are equal to the theoretical values
you calculated on parts a and b. (3 marks)
d) What is firm B’s cost of levered equity? (3 marks)
e) What is firm B’s WACC, and the Enterprise Value and Equity Value derived from the DCF
methodology? (3 marks)
f) If shares outstanding are proportional to equity in the capital structure (e.g. 100% equity
financing = 4,000 shares), what is the per share value of firm B according to APV and DCF, using
the D/E ratio you calculated in part c? (3 marks)
MERGERS AND ACQUISITIONS
Cookie Monster Inc. (a $15 billion snack food company) is considering acquiring Keebler Elves
but is unsure of how much is should be willing to pay for the target firm. At the moment,
Keebler’s 44 million shares are trading in the market for $67.54 but Cookie Monster’s managers
are convinced that its managers could tease out more value from their operations. Specifically,
they expect to be able to decrease corporate overhead and thus increase the growth rate of
Keebler’s dividends by 1% per year. In order to capture these gains, Cookie Monster will also
have to incur $65 million worth of after-tax restructuring costs at the end of the first year and
another $40 million (after-tax) at the end of year 2. Keebler’s dividend this year was $3.80 and
the appropriate discount rate is 13%.
a) Assuming they can purchase the company for its current share price, how much would
the Keebler acquisition be worth to Cookie Monster? (8 marks)
b) After consulting with their investment bankers, Cookie Monster’s managers believe they
will need to offer Keebler’s shareholders a 10% premium above its current market price
in order to secure its sale. Furthermore, there is some uncertainty about how successful
the integration of the new firm will be with the worst case scenario (20% chance of
occurring) resulting in no change in Keebler’s dividend growth. Assuming a 100% cash
deal, what is the maximum loss Cookie’s shareholders can incur? (4 marks)
c) If Cookie Monster instead offers Keebler a 15% premium on its current price but the deal
offers them new shares in Cookie Monster instead of cash, what is the maximum loss
Cookie’s shareholders original shareholders can incur? (8 marks)
1. FIRM VALUATIONLast year firm a generated $10,000 of FCF. FCF is not expected to grow, but will be earnedin perpetuity. Firm A is entirely financed with equity, and its beta is 1.4. The…

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