Finance and accounting - Case Study Example

Finance and accounting [Insert al affiliation] In the business world, firms/companies consider acquiring other firms to expand the market share alongside enhancing the value of the company. In this case, American Cable Communications which is among the largest firms in U.S is considering acquiring Air Thread Connections Company that deals with the manufacturing and supply of electronic products. Robert Zimmerman believes that the two companies can assist each other against competitors in the industries that were sky rocketing in offering their respective services. Additionally, it is anticipated that the two companies will expand their business market through the acquisition. For the acquisition to be considered viable, the acquired firm must be evaluated. The paper is candidly and comprehensively going to employ different valuation concepts in valuation of the firm. Among the concepts are employed include the discount cash flow by use of adjusted present value and the weighted average cost of capital. The paper takes into account the impact of Dividend to value ratio and constant debt in the estimation of cost of capital and beta for the company. Valuation of terminal value via WACC The WACC reflects the aggregate cost to the financial institution with regard to the company. It is the value that represents the total return that is required by equity or debt holders against the investment in the firm. The risk free-rate is the interest rate charged on the treasury bonds to reflect the bonds of the government as the price that is risk free. The beta of the firm measures the risk of the stock and was taken basing on the average of the industry. The average beta factor that is used is 0.78. The additional information that facilitated the qualification include the working capital averagely 28.1%, the risk free interest 4.25% respect to a tax shield of 40% and cost of equity 7.79%. The above information facilitated the computation of WACC which in this case is 8.33% in the excel file. EXHIBIT 7 In the paper, we assume that the debt beta of the competitor companies is zero and further assume that their respective debts are of superior quality. The present yield of an US treasury is at 4.25% equivalent to the risk free rate. The cost of debt is 5.5%. The estimated unlevered Beta for the company is 0.708 The equity risk free premium rate is 5% Employing the capital pricing model, the cost of equity = Risk free rate + Unlevered Beta+ Equity Risk Premium. =4.25+ (0.708*5) = 7.79% For computation of terminal value, the long-term rate of growth for cash flows is 3% which is reasonable rate for developed economy. Cash flows are computed by EBIT (1-Tax rate) + Depreciation – Net working capital. We shall consider using the average present value so the Future Cash flows are discounted by using equity cost of capital. For discounting the terminal value, the WACC is used considering that after 5 years, the company leverage ratio will be constant and in conforming with the competitors in the industry. The present value of equity affiliates are computed by multiplying it with the average price to Earnings ratio. The unlevered cost of capital for computation of the firm is 7.37%. Because dividend to earnings ratio is changing from one year to the other, the adjusted present value is the best method for valuation of the firm. By the help of Exhibit 1 in the our case, the Net working capital for Air Thread communication is without the anticipated synergy for the predicted years is computed as shown: 2008 2009 2010 2011 2012 Working capital Assumptions 521.93 595 669.37 736.1 787.85 Accounts receivables 134 153.86 173.1 190.41 203.73 Prepaid Expenses 46.89 53.46 60.14 66.15 70.78 Accounts payable 335.45 382.42 430.22 473.24 506.37 Deferred Serv. Revenue 132.24 150.75 169.59 186.55 199.61 Accrued liabilities 64.66 73.71 82.92 91.21 97.6 Net working capital 171.4 195.4 219.9 241.9 258.8 Change in working capital 56.8 24 24.4 22 16.9 Additionally, in order to get the unlevered free cash flows, we need to reduce the impact of interest payment. The interest payment computed on the debt is as give below. Interest repayment on Debt 2008 2009 2010 2011 2012 Interest Expense per annum 199.43 183.08 165.8 147.55 128.27 Principal payment per annum 289.92 306.28 323.55 341.8 2495.99 After tax interest expense 119.66 109.85 99.48 88.53 76.96 Tax shield (40%) 79.77 73.23 66.32 59.02 51.31 PV tax shield 75.61 65.79 56.48 47.64 39.26 The total present value of the tax shield in this case is $284.78. The adjusted present value of Air Thread is the summation of the present value of total cash flows, present value of interest tax shield and present value of terminal value. The cash flows are discounted at a discounting rate of 7.37%. The formula for discounting the future ash flow is given by where kd is the discounting rate (7.37%) and n is the number of years. The present values are apparently computed in the excel file. The terminal value is computed as Terminal value = = 13,465 The present value for the terminal value is calculated as: = $9, 436 From the Excel file: The total present value of total cash flows is $2,071.15 The present value for terminal value is $9, 436.00 The total present value for tax shield is $284.78 Interest tax shield $79.77 $73.23 $66.32 $59.02 $51.31 PV tax shield $75.61 $65.79 $56.48 $47.64 $39.26 $284.78 The total present value for the firm is therefore, (2071.15+9436.00+284.78) = $11, 791.93. Calculating cash flows and present value   2008 2009 2010 2011 2012 Service revenue $4,194.30 $4,781.50 $5,379.20 $5,917.20 $6,331.40 Equipment revenue $314.80 $358.80 $403.70 $441.10 $475.20 System operating expenses $838.90 $956.30 $1,075.80 $1,183.40 $1,266.30 Cost of equipment sold $755.50 $861.20 $968.90 $1,065.80 $1,140.40 Selling, General & Administrative $1,803.60 $2,056.20 $2,313.20 $2,544.50 $2,722.60 Depreciation & Amortization $705.20 $804.00 $867.40 $922.40 $952.90 EBIT $405.90 $462.60 $557.60 $642.20 $724.40 Interest (5.50%) $199.43 $183.08 $165.80 $147.55 $128.27 Taxable income $206.47 $279.52 $391.80 $494.65 $596.13 Taxes (40%) $82.59 $111.81 $156.72 $197.86 $238.45 Operating cash flow $123.88 $167.71 $235.08 $296.79 $357.68 Change in net working capital $66 $33 $33.20 $36.50 $28.20 Net capital spending $180.60 $213.10 $246.30 $282.80 $310.90 Un-levered cash flow from assets $246.60 $245.60 $279.50 $319.30 $339.10             Interest tax shield $79.77 $73.23 $66.32 $59.02 $51.31 PV tax shield $75.61 $65.79 $56.48 $47.64 $39.26 Total cash flow $370.48 $413.31 $514.58 $616.09 $696.78 PV cash flow $345.05 $358.52 $415.72 $463.57 $488.29 Terminal value         $13,465.00             Present value $11,507.15         The net present value capital budgeting criterion states that if the net present value of the firm is negative, rejects the investment, and if the net present value is zero then the manager is indifferent and therefore consider other factors. However, if the net present value of the firm is positive, then consider investing in such an investment as it contributes to the increase in the firm’s value. In our case, the Air Thread has a positive net present value of $11, 791.93 and therefore, Air Thread Company is worthy to be acquired by American Cable Communication. Read More