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Question 3

The appropriate discount rate for valuing the acquisition is the weighted average cost of capital (WACC) of 6.54%. Under the expected scenario, the value of the acquisition to Broadway is $172 million. Under a pessimistic scenario, the value is $88.9 million. Both values exceed Harris's $120 million bid. Therefore, Harris should proceed with the acquisition as the benefits outweigh the risks even under pessimistic conditions.

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29 views3 pages

Question 3

The appropriate discount rate for valuing the acquisition is the weighted average cost of capital (WACC) of 6.54%. Under the expected scenario, the value of the acquisition to Broadway is $172 million. Under a pessimistic scenario, the value is $88.9 million. Both values exceed Harris's $120 million bid. Therefore, Harris should proceed with the acquisition as the benefits outweigh the risks even under pessimistic conditions.

Uploaded by

BRIAN WAMBUI
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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3. What is the appropriate discount rate of valuing the acquisition?

Derive the Pro forma

free cash flows of landmark and Broadway and value both companies after the acquisition,

what is the value of this acquisition to Broadway, under expected and pessimistic

scenarios? Should Harris proceed with his $120 million bid?

The discount rate for valuing the acquisition = weighted average cost of capital

Cost of equity for landmark facility= capital asset pricing (Beta model)

Landmark facility in this case is not defined

However, we can apply the equity Betas provided to come up with unlevered beta

Levered beta assists to get cost of equity using CAPM,

Risk free rate= 10 yrs. treasury bonds @2.56%

Market risk premium = 5.9%

Cost of debt= 1- cost of equity

CAPM, cost of equity = Rf + β*(Rm)

βUnlevered = βLevered/ (1+Debt (1-t)/Equity)

= (5.9-2.56)

3.46

Discount Rate= (10-3.46)

=6.54%
Pro forma free cash flows of landmark and Broadway

The free cash flow has been given in the excel sheet.

From the normal expected condition, it was identified the value was $172 million whereas in the

pessimistic case, it was $88.9 million.

Expected Case

2015 2016 2017 2018 2019

Net Sales 168.4 175.1 182.1 189.4 197 Net Sales

Operating Operating

profit 6.7 7 7.3 7.6 7.9 profit

interest 0.4 0.4 0.4 0.4 0.4 interest

Net Income 4.1 4.3 4.5 4.7 4.9 Net Income

Depreciatio

n 3.1 3.3 3.5 3.7 3.9 Depreciation

Change in Change in

net working net working

profit 0.4 0.4 0.4 0.4 0.4 profit

Capital Capital

expenditure 4.2 4.4 4.6 4.7 4.9 expenditure

Normal expected Condition= $172

million
Pessimistic Case

2015 2016 2017 2018

Net Sales 362.8 380.9 400 420

Operating profit 5.4 5.7 6 6.3

Net Income 3.5 3.7 3.9 4.1

Depreciation 2.1 2.4 2.7 3

Change in net

working profit 1.3 1.3 1.4 1.5

Capital

expenditure 3.6 3.8 4 4.2

Pessimistic =$88.9 million

Harris should therefore go ahead and accept the provisions of the deal within the normal

conditions since the landmark value shown is far much higher from what the company is giving

for it. Even in the case of pessimistic value, there is only a slight change to the estimated cost

and therefore the benefits outdoes the negatives.

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