Answer To: The following represents the target's accounting data you've estimated for the years XXXXXXXXXX Fall...
Harshit answered on Jun 12 2021
Solution to Question 5
1. Appropriate cash flows:
2020
2021
Revenue
$100,000,000
$120,000,000
Less:
Cost of Goods Sold
$30,000,000
$55,000,000
Depreciation
$10,000,000
$15,000,000
A&G
$8,000,000
$11,000,000
Interest
$4,000,000
$5,000,000
Profit before tax
$48,000,000
$34,000,000
Less: Tax @35%
$16,800,000
$11,900,000
Profit after tax
$31,200,000
$22,100,000
Add: Depreciation
$10,000,000
$15,000,000
Less: Retained earning
$2,000,000
$3,000,000
Cash Flows
$39,200,000
$34,100,000
2. Calculation of the appropriate discount rate are
Appropriate Discount rate is cost of equity.
By CAPM, cost of equity will be:
Ke = Rf + (Rm-Rf)
(Risk Premium)*
Therefore, discount rate to be used is 15.8%
3. Discount rate is high due to high beta (). Beta represents the sensitivity of firm with respect to market. High sensitivity means high risk. The higher the risk higher will be risk premium. Here the Beta of target firm is 1.8 which when multiplied with risk premium resulted in high discount rate.
4. Value of target firm:
Initial Phase
2020
2021
Revenue
$100,000,000
$120,000,000
Less:
Cost of Goods Sold
$30,000,000
$55,000,000
Depreciation
$10,000,000
$15,000,000
A&G
$8,000,000
$11,000,000
Interest
$4,000,000
$5,000,000
Profit before tax
$48,000,000
$34,000,000
Less: Tax @35%
$16,800,000
$11,900,000
Profit after tax
$31,200,000
$22,100,000
Add: Depreciation
$10,000,000
$15,000,000
Less: Reatined earning
$2,000,000
$3,000,000
Cash Flows
$39,200,000
$34,100,000
Discounting factor @ 15.8%
0.8636
0.7457
Present value of cash...