Home Appliances, a large appliance manufacturer, is considering an acquisition of Modern Design, a medium appliance manufacturer. You have been provided with the following information: Home Appliances Modern Design After-tax operating income next year Debt capital ratio Cost of debt $20 million $10 million 20% 4% $6 million 0% Net Capex + ANWC $1.5 million Both companies are in stable growth, growing at 3% a year. The appliance sector has an unlevered beta of 0.8 for large firms and 1 for small and medium size firms. The marginal tax rate for all firms is 30%. Assume constant D/E ratio to both firms in the equilibrium. The risk-free rate is 3%, and the expected market risk premium is 6%. a. What is the Enterprise Value of Home Appliance as a stand-alone company? b. What is the Enterprise Value of Modern Design as a stand-alone company? c. Home Appliance plans to acquire the entire firm of Modern Design and integrate it into its own business. It will pay a 30% premium on the owner's estimated value ( from part b) and use a 20% debt-to-capital ratio (with the cost of debt remaining at 4%) to finance the acquisition. Estimate the value of Home Appliance after the transaction. How would you expect Home Appliance's stock price to change upon the announcement?
Home Appliances, a large appliance manufacturer, is considering an acquisition of Modern Design, a medium appliance manufacturer. You have been provided with the following information: Home Appliances Modern Design After-tax operating income next year Debt capital ratio Cost of debt $20 million $10 million 20% 4% $6 million 0% Net Capex + ANWC $1.5 million Both companies are in stable growth, growing at 3% a year. The appliance sector has an unlevered beta of 0.8 for large firms and 1 for small and medium size firms. The marginal tax rate for all firms is 30%. Assume constant D/E ratio to both firms in the equilibrium. The risk-free rate is 3%, and the expected market risk premium is 6%. a. What is the Enterprise Value of Home Appliance as a stand-alone company? b. What is the Enterprise Value of Modern Design as a stand-alone company? c. Home Appliance plans to acquire the entire firm of Modern Design and integrate it into its own business. It will pay a 30% premium on the owner's estimated value ( from part b) and use a 20% debt-to-capital ratio (with the cost of debt remaining at 4%) to finance the acquisition. Estimate the value of Home Appliance after the transaction. How would you expect Home Appliance's stock price to change upon the announcement?
Chapter16: Working Capital Policy And Short-term Financing
Section: Chapter Questions
Problem 11P
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Transcribed Image Text:Home Appliances, a large appliance manufacturer, is considering an acquisition of Modern Design, a medium
appliance manufacturer.
You have been provided with the following information:
Home
Modern Design
Appliances
After-tax operating income
next year
Debt capital ratio
$20 million
$10 million
20%
0%
Cost of debt
4%
Net Capex + ANWC
$6 million
$1.5 million
Both companies are in stable growth, growing at 3% a year.
The appliance sector has an unlevered beta of 0.8 for large firms and 1 for small and medium size firms.
The marginal tax rate for all firms is 30%. Assume constant D/E ratio to both firms in the equilibrium.
The risk-free rate is 3%, and the expected market risk premium is 6%.
a. What is the Enterprise Value of Home Appliance as a stand-alone company?
b. What is the Enterprise Value of Modern Design as a stand-alone company?
c. Home Appliance plans to acquire the entire firm of Modern Design and integrate it into its own business.
It will pay a 30% premium on the owner's estimated value ( from part b) and use a 20% debt-to-capital
ratio (with the cost of debt remaining at 4%) to finance the acquisition.
Estimate the value of Home Appliance after the transaction.
How would you expect Home Appliance's stock price to change upon the announcement?
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