Kelly tubes is considering a merger with reilly tires

Question

1. Great Subs, Inc., a regional sandwich chain, is considering purchasing a smaller chain, Eastern Pizza, which is currently financed using 20% debt at a cost of 8%. Great Subs' analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117 million in Year 4. (The Year 4 cash flow includes the horizon value of $107 million.) The acquisition would be made immediately, if it is to be undertaken. Eastern's pre-merger beta is 3.1, and its post-merger tax rate would be 34%. The risk-free rate is 6%, and the market risk premium is 4.5%. What is the appropriate rate to use in discounting the free cash flows and the interest tax savings if you use the Adjusted Present Value approach?
2. Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Laker is expected to have NOPAT of $28 million and interest expense of $6 million. Also, in the second year only, Laker will need $10 million of net new investment in operating capital. Laker's marginal tax rate is 40%. After the second year, the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 3%. Blazer has determined that Laker's cost of equity is 18.0%, and Laker currently has no debt outstanding. Assume that all cash flows occur at the end of the year and that Blazer must pay $45 million to acquire Laker. What is the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.
3. Rainier Bros. has 10.0% semiannual coupon bonds outstanding that mature in 10 years. Each bond has a par value of $1,000 and is now eligible to be called at $1,090. If the bonds are called, the company must replace them with new 10 year bonds. The flotation cost of issuing the new bonds is estimated to  be $45 per bond. How low would the yield to maturity on the new bonds have to be for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?
4. Its investment bankers have told Donner Corporation that it can issue a 25 year, 8.0% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 35% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.5%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?
5. Valdes Enterprises is considering issuing a 10 year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 9.50%. The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 6.00%. What is the estimated floor price of the  convertible at the end of Year 3?
6. Dunbar Hardware, a national hardware chain, is considering purchasing a smaller chain, Eastern Hardware. Dunbar's analysts project that the merger will result in incremental free cash flows and interest tax savings with a combined present value of $92.52 million, and they have determined that the appropriate discount rate for valuing Eastern is 16%. Eastern has 8 million shares outstanding and no debt. Eastern's current price is $10.25 per share. What is the maximum price per share that Dunbar should offer?
7. Tuttle Buildings Inc. has decided to go public by selling $5,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (7% of gross proceeds versus their normal 10%) in exchange for a 1 year option to purchase an additional 250,000 shares at $5.00 per share. The investment bankers expect to exercise the option and purchase the 250,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per share one year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker's required return on such arrangements is 21% and ignore taxes.
8. Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3 year life. It can borrow $5,900,000, the purchase price, at 11% and buy the tools, or it can make 3 equal beginning-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3 year simple interest loan, with interest paid at the end of the year and the full loan amount repaid at the end of year 3. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $290,000, but this cost would be borne by the lessor if it leases. Assume annual maintenance costs are paid at the beginning of each year. What is the net advantage to leasing (NAL) for Kohers?
9. Curry Corporation is setting the terms on a new issue of bonds with warrants. The bonds will have a 30 year maturity and annual interest payments. Each bond will come with 25 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $15.00. A similar straight-debt issue would require a 8.5% coupon rate. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000?
10. Brau Auto, a national autoparts chain, is considering purchasing a smaller chain, South Georgia Parts (SGP). Brau's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values, in millions of dollars: Year                             1             2             3
    Free Cash Flows       $ 1.00      $ 3.00      $ 3.00 
    Unlevered Horizon Value 
    Tax Shield               $ 1.00       $ 1.00      $ 2.00 
    Horizon Value of Tax Shield
11. Assume that all cash flows occur at the end of the year. SGP is currently financed with 40% debt at a rate of 10%. The acquisition will be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 40% target level. The interest rate will remain the same. SGP's per-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 7% and the market risk premium is 4%. What is the value of SGP to Brau?
12. Kelly Tubes is considering a merger with Reilly Tires. Reilly's market-determined beta is 1.1, and the firm is financed with 20% debt, at an interest rate of 7.5%, and its tax rate is 25%. If Kelly acquires Reilly, it will increase the debt to 60%, at an interest rate of 9.50%, and the tax rate will increase to 35%. The risk-free rate is 6% and the market risk premium is 5%. What will Reilly's required rate of return on equity be after it is acquired?
13. Europa Corporation is financing an ongoing construction project. The firm will need $9,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 30% debt and 70% equity, and it wants to be at that structure in 3 years, when the project is completed. Debt flotation costs for a single debt issue would be 1.7% of the gross debt proceeds. Yearly flotation costs for three separate issues of debt would be 3.1% of the gross amount. Ignoring time value effects, how much would the firm save by raising all the debt now, in a single issue, rather than in 3 separate issues? Remember that the $9,000,000 of new capital needed during each of the new 3 years is the amount needed net of flotation costs. 
14. Buster's Beverages is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3 year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $28,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 35% tax bracket, and it could obtain a 3 year simple interest loan, with interest payable at the end of each year, to purchase the equipment at a before-tax cost of 10%, with all  loan principle to be repaid at the end of year 3. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. What is the NAL?
15. Which of the following statements is most CORRECT? a. If a company that produces military equipment merges with a company that manages a chain of motels, this is an example of a horizontal merger. b. A defensive merger is one where the firm's managers decide to merge with another firm to avoid or lessen the possibility of being acquired through a hostile takeover. c. Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the acquisition. d. None of the statements above is correct. e. Answers a and c are correct.
16. Which of the following statements is most CORRECT? a. Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers. b. The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed. c. Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger. d. Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what's probably a lower cost, diversification benefits is generally not a valid motive for a publicly held firm. e. All of the answers above are correct.
17. A lease versus purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased a. is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC. b. is financed with retained earnings. c. is financed with long-term debt. d. is financed with short-term debt. e. is financed with debt whose maturity matches the term of the lease.
18. Which of the following statements is most CORRECT? a. Warrants have an option feature but convertibles do not. b. One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. c. The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. d. The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. e. Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.