Company A with excess cash is considering the acquisition of company B.
Company A estimates of B’s earnings potential if it comes under A’s management (in millions of dollars). The interest expense listed here includes the interest (1) on B’s existing debt, (2) on new debt that A would issue to help finance the acquisition, and (3) on new debt expected to be issued over time to help finance expansion within the new “B division,” the code name given to the target firm. The retentions represent earnings that will be reinvested within the B division to help finance its growth.
Company B currently uses 35% debt financing, and it pays federal-plus-state taxes at a 35% rate. Security analysts estimate B’s beta to be 1.15. If the acquisition were to take place, A’s would increase B’s debt ratio to 45%, which would increase B’s beta to 1.29. Further, because company A is highly profitable, taxes on the consolidated firm would be 40%. Depreciation cash flows would have to be reinvested within the division to replace worn-out equipment.
You estimate the risk-free rate to be 4% and the return on the market to be 13%. You also estimate that cash flows after 2021 will grow at a constant rate of 5%. The after tax cost of debt is 8%.
The table presents estimates of the company B’s data for merger analysis (in millions of dollars)
2018 2019 2020 2021
Net Sales 50 70 98 120
COGS 28 48 71 82
Selling & Admin Expenses 3 5.5 6.5 7.5
Interest Expense 2 2.5 3.5 4
Necessary Retained Earnings 0 6.5 8.0 6
What is the cash flow for year 2021 (The cash flow to be used for merger analysis)? 97,521,364.74
67,128,164.54
114,360,850.36
107,873,609.80
85,364,415.76