M&a Valuation Practice

Valuation of a Merger and Acquisition using Discounted Cash flow technique (20 points)

It is 1st of January, 2015. AIS Communications Inc., a large telecommunications company is evaluating the possible acquisition of Coit Cable Company (CCC), a regional mobile phone company.  AIS’s analysts project the following postmerger data for CCC (in thousands of dollars):

                                2015                2016                2017                2018

Net sales                         $650                $718                $855                $900

Selling and Administrative             85                    93                      100                   108

Interest                                          28                   31                   34                     37

Tax rate                                                        20 percent

Cost of service as a percent of sales                                       60 percent

Beta of the target firm after the acquisition                            1.6

Beta of the acquirer after the acquisition                                1.2

Risk free rate                                                          8 percent

Market risk premium                                                     4 percent

Terminal growth rate of cash flow available to AIS 5 percent

If the acquisition is made, it will occur on January 1, 2015.  All cash flows shown in the income statements are assumed to occur at the end of the year.  CCC currently has a capital structure of 40 percent debt, but AIS would increase that to 50 percent if the acquisition were made.  CCC, if independent, would pay taxes at 30 percent, but its income would be taxed at 20 percent if it were consolidated.  CCC’s current market-determined beta is 1.4, and its investment bankers think that its beta would rise to 1.6 if the debt ratio were increased to 50 percent.  The current loan outstanding is $660,000 and cost of debt is 5 percent per annum.    The beta of the acquirer would be 1.2.  The cost of goods sold is expected to be 60 percent of sales.  Depreciation-generated funds would be used to replace worn-out equipment, so they were not available to AIC’s shareholders (Depreciation is equal to the capital expenditure).  The required additional working capital is zero.  There is no plan to repay the loan outstanding recently.   The risk-free rate is 8 percent, and the market risk premium is 4 percent.