Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP). Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:
|
Year
|
1
|
2
|
3
|
4
|
|
Free cash flow
|
$1
|
$3
|
$3
|
$7
|
|
Unlevered horizon value
|
|
|
|
75
|
|
Tax shield
|
1
|
1
|
2
|
3
|
|
Horizon value of tax shield
|
|
|
|
32
|
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would 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 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Raymond?