Managerial Finance Discussion Questions
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Managerial Finance
Ronson Inc.; a technology company, is evaluating the possible acquisition of Blake equipment company. If the acquisition is made, it will occur on January 1, 2009. All cash flows shown in the income
statements are assumed to occur at the end of the year. Blake currently has a capital structure of 40%
debt, but Ronson would increase that to 50% if the acquisition were made. Blake, if independent,
would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. Blake’s current
market-determined beta is 1.40, and its investment bankers think that its beta would rise to 1.50 if the
debt ratio were increased to 50%. The cost of goods sold is expected to be 65% of sales, but it could vary
somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not
be available to Ronson’s shareholders. The risk-free rate is 8%, and the market risk premium is
4%.
a. What is the appropriate discount rate for valuing the acquisition?
b. What is the terminal value?
c. What is the value of Blake to Ronson?
d. Suppose, Blake has 120,000 shares outstanding. What is the maximum per share price Ronson should
offer for Blake?
Ronson management project the following post merger financial data (thousands of dollars
2009201020112012
Net sales$450$518$555$600
Selling and administrative expense45536068
Interest18212427
Tax rate after merger35%
Cost of goods sold as a % of sales65%
Beta after merger1.5
Risk-free rate8%
Market risk premium4%
Terminal growth rate of cash flow7%
available to Madison
2009201020112012
Sales$450.0$518.0$555.0$600.0
Cost of Goods Sold (65%)292.5336.7
Gross Profit157.5181.3
Selling/admin. costs45.053.0
EBIT112.5128.3
Interest18.021.0
EBT94.5107.3
Taxes (35%)33.137.6
Net Income/Cash Flow$61.4$69.7
* In this scenario, we state that net income and net cash flow are equal. This assumption arises from the
fact that depreciation-generated funds would be used to replace worn-out equipment, and would not be
available to shareholders.
To calculate the terminal value, we must determine the net cash flow for 2013. This is derived as the
2012 net cash flow expanded at the terminal growth rate of cash flows. From this point, we can derive
terminal value from the basic DCF framework.
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