Problem 1
On July 3, 2015, health insurer Aetna Inc. announced its decision to acquire smaller rival Humana Inc. This is considered as one of the largest deals in the insurance industry.
Here is some information on pre-transaction prices and shares outstanding of two companies.
Aetna Inc.
• Stock price as of July 2, 2015: $125.51 per share
• Number of shares outstanding (pre-transaction) 348.60 million
Humana Inc.
• Stock price as of July 2, 2015: $187.50 per share
• Number of shares outstanding (pre-transaction) 149.78 million
Aetna is offering $230 per share to Humana shareholders using a combination of cash and stock. The cash portion of the offer is $125 in cash. The remaining consideration would be offered as Aetna stock in exchange for Humana stock.
Assuming no synergies in the merger, what is the maximum exchange ratio that Aetna can offer to Humana shareholders without diluting the value of its own stock? Please input your answer in the box below and round to three decimal points.
Problem 2
Bond Corp is a manufacturing firm with no debt outstanding. It is considering borrowing $25 million at 8 percent and using the proceeds to buy back shares. Its equity market value is $100 million, and its profits are taxed at 35 percent.
a. What would be the present value of the interest tax shield if the debt is permanent? Write your answer in millions and round to two decimal points.
b. What would be the present value of the interest tax shield if the interest rate increases to 9 percent immediately after the debt is issued? Write your answer in millions and round to two decimal points.
Problem 3
Assume it is January 1, 1994 and Northrop and Grumman are considering a merger. Here is some information on Northrop and Grumman.
|
Fiscal year ending
December 31, 1993
(amounts are in $ millions)
|
|
|
Northrop
|
Grumman
|
|
Revenues
|
$4,400.00
|
$3,125.00
|
|
Cost of Goods Sold (with depreciation)/revenue
|
87.50%
|
89.00%
|
|
Tax Rate (both marginal tax rate and cash tax rate)
|
35%
|
35%
|
|
Operating working capital/revenue
|
10%
|
10%
|
|
Debt (book value)
|
$430
|
$730
|
|
Market Value of Equity
|
$4970
|
$3070
|
Both firms are in steady state and are expected to grow 5% a year in the long-term. The firms have no other pre-tax operating expenses except the cost of goods sold. Capital expenditure is expected to offset depreciation. The equity beta for both firms is 1, and both firms are rated A. Bonds with A rating offer an average yield to maturity of 7.5%. The Treasury bond rate is 7%. The market risk premium is 5 percent.
As a result of the merger, the combined firm is expected to have a cost of goods sold of only 86% of total revenues (which is the only source of operating synergy in the merger). The combined firm does not plan to borrow additional debt. Assume that the combined firm debt would also be rated A. Beta of equity of the combined firm will remain at 1.0 if it does not borrow additional debt.
(a) Estimate the value of Grumman, operating independently.
(b) Estimate the value of Northrop, operating independently.
(c) Estimate the value of the combined firm, with no synergy.
(d) Estimate the value of the combined firm, with synergy. Use the same WACC as in (c).
(e) How much is operating synergy worth?
(f) Now assume that as a result of the merger, the firm's optimal debt ratio increases to 30% of firm value from current levels. At that level of debt, the combined firm will have a BB rating, with an interest rate on its debt of 8%. Estimate the value of the combined firm (with synergy) if it moves to its optimal debt ratio.
Please round your answers to nearest millions of dollars.
Problem 4
The following were the P/E ratios of firms in the aerospace/defense industry at the end of December 1993, with additional data on expected growth and risk. The risk-free rate in the US at the end of 1993 is 7.5 percent and the US market risk premium is 5.5 percent.
|
Company
|
P/E ratio
|
Expected growth
|
Beta
|
Dividend payout ratio
|
|
Boeing
|
17.3
|
3.5%
|
1.10
|
28%
|
|
General Dynamics
|
15.5
|
11.5%
|
1.25
|
40%
|
|
GM - Hughes
|
16.5
|
13.0%
|
0.85
|
41%
|
|
Grumman
|
11.4
|
10.5%
|
0.80
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37%
|
|
Lockheed Corp.
|
10.2
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9.5%
|
0.85
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37%
|
|
Logicon
|
12.4
|
14.0%
|
0.85
|
11%
|
|
McDonnell Douglas
|
22.6
|
13.0%
|
1.15
|
37%
|
|
Northrop
|
9.5
|
9.0%
|
1.05
|
47%
|
|
Raytheon
|
12.1
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9.5%
|
0.75
|
28%
|
|
Thiokol
|
8.7
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5.5%
|
0.95
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15%
|
|
Average
|
13.62
|
9.9%
|
0.96
|
32.1%
|
An analyst concludes that Thiokol is undervalued because its P/E ratio is lower than the industry average. The same analyst thinks that McDonnell Douglas is overvalued because its P/E ratio is high.
Problem: Under what conditions are these statements true? Would you agree with these statements given the data in the table?
It is the end of 2013, and KOC Inc. has just received a buyout offer from a private equity firm. Upon receiving the offer, KOC's board set up a special committee to evaluate the offer and to make recommendations about the transaction.
The special committee would like you to estimate the value of KOC based on management forecasts given below. Due to the nature of the transaction, you realize that the Capital Cash Flow (CCF) valuation is the most appropriate method. The valuations are to be done as of the end of 2013. KOC is subject to 37.5% tax rate.
KOC is currently debt free, but the transaction will be financed with term loans of $8.9 billion at an interest rate of 7% and bank debt of $12 billion at an interest rate of 8%. The firm pays interest during the year on its beginning-of-the-year debt balances. The outstanding debt amounts over the next five years are given below. Beyond 2018, you expect that KOC's outstanding debt will grow with firm value.
Outstanding Debt:
|
|
Outstanding debt amounts at the end of
|
|
|
2013
|
2014
|
2015
|
2016
|
2017
|
2018
|
|
Term Loan
|
8,900
|
7,900
|
6,900
|
5,900
|
4,900
|
3,900
|
|
Bank Debt
|
12,000
|
10,894
|
8,892
|
6,517
|
3,523
|
29
|
Management Projections of EBIT, Depreciation, and Capital Expenditures:
|
|
Projected Fiscal Year Ending December 31st
|
|
|
2014
|
2015
|
2016
|
2017
|
2018
|
|
EBIT
|
5,360
|
6,537
|
6,927
|
7,628
|
8,123
|
|
Depreciation
|
1,446
|
1,536
|
1,632
|
1,734
|
1,842
|
|
Capital Expenditure
|
1,560
|
1,634
|
1,784
|
1,904
|
2,015
|
Management Projections of Net Working Capital:
|
|
2013 (Actual)
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2014
|
2015
|
2016
|
2017
|
2018
|
|
Net Working Capital
|
348
|
489
|
584
|
640
|
659
|
679
|
Market and Interest Rate Data:
Risk-free rate = 4%
Market risk premium = 6%
Long-term growth rate = 3%
Interest rate on term loan = 7%
Interest rate on bank debt = 8%
Tax rate = 37.5%
Information about Comparable Companies:
|
Company
|
Equity Beta
|
Debt Beta
|
Total Debt ($m)
|
Market value of equity ($m)
|
|
RTH Healthcare
|
1.7
|
0.2
|
5,000
|
3,000
|
|
Health Management Associates
|
0.8
|
0.1
|
2,000
|
6,000
|
|
Community Health Systems
|
0.9
|
0.1
|
3,000
|
5,000
|
Problem 5
What is the cost of unlevered equity of KOC?
8.28%
7.98%
7.32%
9.86%
10.80%
Problem 6
Estimate the free cash flows of KOC for the years 2014 to 2019? Assume that beyond 2018, the free cash flow will grow at the rate of 3% per year in perpetuity. Input your answer rounded to the nearest million but without the dollar sign or the commas.
Problem 7
What are the interest tax shields for years 2014 through 2019? Input your answer rounded to the nearest million but without the dollar sign or the commas.
Problem 8
The enterprise value of KOC is closest to:
$105,965 million
$90,158 million
$60,958 million
$88,267 million
None of the values listed here