Blazer Breaks, Inc. is considering an acquisition of Laker Showtime Company. Blazer expects to receive net cash flows from Laker of $9 million the first year. For the second year, Laker is expected to have EBIT of $25 million and interest expense of $5 million. Also, in the second year only, Laker will require reinvestment of an additional 40 percent of its net income to finance future growth. Laker’s applicable marginal tax rate is 34 percent. After the second year, the net cash flows from Laker to Blazer will grow at a constant rate of 4 percent. The firm has determined that 17.5 percent is the appropriate equity discount rate to apply to this merger. Assume that all cash flows occur at the end of the year and that the Laker acquisition will cost Blazer $45 million. Calculate the net cash flow to Blazer for the second year, use that to determine future cash flows, and determine the present value of the proposed acquisition to Blazer. Ans = 12.6 million
Hints:
First calculate the cash flows for year 2. EBIT- Interest- Taxes- Retained earnings= 7.92 million
In order to find out the present value of proposed acquisition enter CF 0 = Acquisition cost of Laker as of today CF 1= Net cash flow for year 1 and CF2 = Answer to your earlier question + PV of all future cash flows at a constant growth rate of 4%= 68.93m