2.99 See Answer

Question: Marston Marble Corporation is considering a merger

Marston Marble Corporation is considering a merger with the Conroy Concrete Company. Conroy is a publicly traded company, and its beta is 1.30. Conroy has been barely profitable, so it has paid an average of only 20% in taxes during the last several years. In addition, it uses little debt; its target ratio is just 25%, with the cost of debt 9%.If the acquisition were made, Marston would operate Conroy as a separate, wholly owned subsidiary. Marston would pay taxes on a consolidated basis, and the tax rate would therefore increase to 35%. Marston also would increase the debt capitalization in the Conroy subsidiary to wd = 40%, for a total of $22.27 million in debt by the end of Year 4, and pay 9.5% on the debt. Marston’s acquisition department estimates that Conroy, if acquired, would generate the following free cash flows and interest expenses (in millions of dollars) in Years 1–5:
Marston Marble Corporation is considering a merger with the Conroy Concrete Company. Conroy is a publicly traded company, and its beta is 1.30. Conroy has been barely profitable, so it has paid an average of only 20% in taxes during the last several years. In addition, it uses little debt; its target ratio is just 25%, with the cost of debt 9%.If the acquisition were made, Marston would operate Conroy as a separate, wholly owned subsidiary. Marston would pay taxes on a consolidated basis, and the tax rate would therefore increase to 35%. Marston also would increase the debt capitalization in the Conroy subsidiary to wd = 40%, for a total of $22.27 million in debt by the end of Year 4, and pay 9.5% on the debt. Marston’s acquisition department estimates that Conroy, if acquired, would generate the following free cash flows and interest expenses (in millions of dollars) in Years 1–5:
In Year 5, Conroy’s interest expense would be based on its beginning-of year (that is, the end-of-Year-4) debt, and in subsequent years both interest expense and free cash flows are projected to grow at a rate of 6%. These cash flows include all acquisition effects. Marston’s cost of equity is 10.5%, its beta is 1.0, and its cost of debt is 9.5%. The risk-free rate is 6%, and the market risk premium is 4.5%. 
a. What is the value of Conroy’s unlevered operations, and what is the value of Conroy’s tax shields under the proposed merger and financing arrangements? 
b. What is the dollar value of Conroy’s operations? If Conroy has $10 million in debt outstanding, how much would Marston be willing to pay for Conroy?

In Year 5, Conroy’s interest expense would be based on its beginning-of year (that is, the end-of-Year-4) debt, and in subsequent years both interest expense and free cash flows are projected to grow at a rate of 6%. These cash flows include all acquisition effects. Marston’s cost of equity is 10.5%, its beta is 1.0, and its cost of debt is 9.5%. The risk-free rate is 6%, and the market risk premium is 4.5%. a. What is the value of Conroy’s unlevered operations, and what is the value of Conroy’s tax shields under the proposed merger and financing arrangements? b. What is the dollar value of Conroy’s operations? If Conroy has $10 million in debt outstanding, how much would Marston be willing to pay for Conroy?





Transcribed Image Text:

Year Free Cash Flows Interest Expense 1 $1.30 $1.2 2 1.50 1.7 3. 1.75 2.8 2.00 2.1 5 2.12 ? 4.



> WorldCom capitalized some costs that should, under standard accounting practices, have been expensed. Enron and some other companies took similar actions to inflate their reported income and to hide debts. (a) Explain how such improper and illegal actio

> Is it true that the “flatter” (more nearly horizontal) the demand curve for a particular firm’s stock and the less important investors regard the signaling effect of the offering, the more important the role of investment banks when the company sells a n

> Why are financial ratios used? Name five categories of ratios, and then list several ratios in each category. Would a bank loan officer, a bond analyst, a stock analyst, and a manager be likely to put the same emphasis and interpretation on each ratio?

> How might one establish norms (or target values) for the financial ratios of a company that is just getting started? Where might data for this purpose be obtained? Could information of this type be used to help determine how much debt and equity capital

> How would each of the following factors affect ratio analysis? (a) The firm’s sales are highly seasonal. (b) The firm uses some type of window dressing. (c) The firm issues more debt and uses the proceeds to repurchase stock. (d) The firm leases more

> Explain how ratio analysis in general, and the DuPont system in particular, can be used by managers to help maximize their firms’ stock prices

> Much has been made about the sweeping changes that are occurring in Europe as a result of the euro. Will the euro help European firms become more efficient? Will it change the way multinational corporations manage cash? Manage exchange risk? Borrow funds

> How do managers, bankers, and security analysts’ use: (a) trend analysis, (b) benchmarking, (c) percent change analysis, and (d) common size analysis?

> Suppose a company has a DSO that is considerably higher than its industry average. If the company could reduce its accounts receivable to the point where its DSO was equal to the industry average without affecting its sales or its operating costs, how wo

> The rationale behind granting stock options is to induce employees to work harder and be more productive. As the stock price increases (presumably due to their hard work), the employees share in this added wealth. Another way to share this wealth would b

> Should options given as part of compensation packages be reported on the income statement as an expense? What are some pros and cons relating to this issue?

> An unlevered firm has a value of $800 million. An otherwise identical but levered firm has $60 million in debt at a 5% interest rate. Its cost of debt is 5% and its unlevered cost of equity is 11%. No growth is expected. Assuming the corporate tax rate i

> Firm A had no credit losses last year, but 1% of Firm B’s accounts receivable proved to be uncollectible and resulted in losses. Can you determine which firms credit manager is performing better? Why or why not?

> Is it true that if a firm calculates its days sales outstanding, it has no need for an aging schedule? Explain your answer.

> Suppose a firm makes a purchase and receives the shipment on February 1. The terms of trade as stated on the invoice read “2/10, net 40, May 1 dating.” What is the latest date on which payment can be made and the discount still be taken? What is the date

> Suppose a company’s current credit terms are 1/10, net 30, but management is considering changing its terms to 2/10, net 40, relaxing its credit standards, and putting less pressure on slow-paying customers. How would you expect these changes to affect:

> Does its management typically have complete control over a firm’s credit policy? As a general rule, is it more likely that a company would increase its profitability if it tightened or loosened its credit policy?

> Suppose IBM signed a contract to buy a supply of computer chips from a German firm. The price is 10 million euros, and the chips will be delivered immediately, but IBM can delay payment for 6 months if it wants to. What risk would IBM be exposed to if it

> How do each of the items in a firm’s credit policy— defined to include the credit period, the discount and discount period, the credit standards used, and the collection policy—affect its sales, the level of its accounts receivable, and its profitability

> How does credit policy affect the cash conversion cycle as discussed in the last chapter?

> How would you decide whether or not to make the change described in question 4? Assume you also have information on the company’s cost of capital, tax rate, and variable costs. How would the company’s capacity utilization affect the decision?

> Andria Mullins, financial manager of Webster Electronics, has been asked by the firm’s CEO, Fred Weygandt, to evaluate the company’s inventory control techniques and to lead a discussion of the subject with the senior executives. Andria plans to use as a

> Assuming the firm’s sales volume remained constant, would you expect it to have a higher cash balance during a tight-money period or during an easy money period? Why?

> Rich Jackson, a recent finance graduate, is planning to go into the wholesale building supply business with his brother, Jim, who majored in building construction. The firm would sell primarily to general contractors, and it would start operating next Ja

> What four methods are used to account for inventory? What are the financial implications of one method over another? How does the choice of inventory accounting method affect the order in which actual items in inventory are sold? Is it possible for the c

> Discuss some of the techniques available to reduce risk exposures.

> List six reasons why risk management might increase the value of a firm.

> Give two reasons stockholders might be indifferent between owning the stock of a firm with volatile cash flows and that of a firm with stable cash flows.

> What is purchasing power parity? How might a firm use this concept in its operations?

> What are some ways banks can state their charges, and how should the cost of bank debt be analyzed? In the early 1970s, Congress debated the need for new legislation, and it ended up passing a “Truth in Lending” law. One part of the law was the requireme

> At the time it defaulted on its interest payments and filed for bankruptcy, the McDaniel Mining Company had the balance sheet shown below (in thousands of dollars). The court, after trying unsuccessfully to reorganize the firm, decided that the only reco

> Chapman Inc.’s Mexican subsidiary, V. Gomez Corporation, is expected to pay to Chapman 50 pesos in dividends in 1 year after all foreign and U.S. taxes have been subtracted. The exchange rate in 1 year is expected to be 0.10 dollars per peso. After this,

> Assume that interest rate parity holds and that 90-day risk-free securities yield 5% in the United States and 5.3% in Germany. In the spot market, 1 euro equals $1.40. What is the 90-day forward rate? Is the 90-day forward rate trading at a premium or a

> The Verbrugge Publishing Company’s 2015 balance sheet and income statement are as follows (in millions of dollars): Verbrugge and its creditors have agreed upon a voluntary reorganization plan. In this plan, each share of the $6 preferr

> Boisjoly Watch Imports has agreed to purchase 15,000 Swiss watches for 1 million francs at today’s spot rate. The firm’s financial manager, James Desreumaux, has noted the following current spot and forward rates: On t

> In 1983, the Japanese yen-U.S. dollar exchange rate was 245 yen per dollar, and the dollar cost of a compact Japanese-manufactured car was $8,000. Suppose that now the exchange rate is 80 yen per dollar. Assume there has been no inflation in the yen cost

> Your Boston-headquartered manufacturing company, Wruck Enterprises, obtained a 50 million-peso loan from a Mexico City bank last month to fund the expansion of your Monterrey, Mexico plant. When you took out the loan, the exchange rate was 10 U.S. cents

> Assume that interest rate parity holds. In both the spot market and the 90-day forward market, 1 Japanese yen equals 0.0086 dollar. In Japan, 90-day risk-free securities yield 4.6%. What is the yield on 90-day risk-free securities in the United States?

> The nominal yield on 6-month T-bills is 7%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 5.5%. In the spot exchange market, 1 yen equals $0.009. If interest rate parity holds, what is the 6-month forward exchange rate?

> At today’s spot exchange rates 1 U.S. dollar can be exchanged for 9 Mexican pesos or for 111.23 Japanese yen. You have pesos that you would like to exchange for yen. What is the cross rate between the yen and the peso; that is, how many yen would you rec

> The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project’s expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $

> What are horizontal, vertical, congeneric, and conglomerate mergers? Are the different types of mergers equally likely to pass muster with the Justice Department?

> Acquisitions can have important tax consequences depending on: (a) Whether the acquiring firm purchases the target’s stock or just its assets, (b) whether cash or stock is used for the payment, and (c) how the acquirer records the target’s assets on i

> Explain how purchase accounting is implemented in a merger. Does the accounting profession now require this method? How is any premium that the acquiring firm paid over the acquired firm’s book value treated subsequent to a merger?

> Southwestern Wear Inc. has the following balance sheet: The trustee’s costs total $281,250, and the firm has no accrued taxes or wages. The debentures are subordinated only to the notes payable. If the firm goes bankrupt and liquidates,

> If you were conducting a merger analysis, would you give the multiples method or one of the DCF methods (that is, the APV or corporate valuation model) more weight in your decision? Explain.

> Explain how the market multiples method is used to determine the value of a target firm to a potential acquirer. Give several examples of this procedure.

> Many companies have serious discussions about merging. Sometimes these discussions lead to mergers, sometimes not. What are some factors that should be considered and that affect the likelihood of a merger actually being completed?

> What is synergy? What are some factors that might lead to synergy? How is the amount of synergy in a proposed merger measured, and how is it allocated between the two firms’ stockholders? Would the four types of mergers as discussed in Question 1 be equa

> Assuming the same information as for Problem 26-2, suppose Hastings will increase Vandell’s level of debt at the end of Year 3 to $30.6 million so that the target capital structure is now 45% debt. Assume that with this higher level of debt the interest

> Hastings estimates that if it acquires Vandell, interest payments will be $1.5 million per year for 3 years, after which the current target capital structure of 30% debt will be maintained. Interest in the fourth year will be $1.472 million, after which

> Vandell’s free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1.4. What is the value of Vandell’s operations? If Vandell has $10.82 million in debt, what is the current value of Vandell’s stoc

> VolWorld Communications Inc., a large telecommunications company, is evaluating the possible acquisition of Bulldog Cable Company (BCC), a regional cable company. VolWorld’s analysts project the following post-merger data for BCC (in th

> The following balance sheet represents Boles Electronics Corporation’s position at the time it filed for bankruptcy (in thousands of dollars): The mortgage bonds are secured by the plant but not by the equipment. The subordinated debent

> If the United States imports more goods from abroad than it exports, then foreigners will tend to have a surplus of U.S. dollars. What will this do to the value of the dollar with respect to foreign currencies? What is the corresponding effect on foreign

> If the Swiss franc depreciates against the U.S. dollar, can a dollar buy more or fewer Swiss francs as a result?

> Exchange rates fluctuate under both the fixed exchange rate and floating exchange rate systems. What, then, is the difference between the two systems?

> With the growth in demand for exotic foods, Possum Products’ CEO Michael Munger is considering expanding the geographic footprint of its line of dried and smoked low-fat opossum, ostrich, and venison jerky snack packs. Historically, jer

> Under the fixed exchange rate system, what was the currency against which all other currency values were defined? Why?

> Kimberly MacKenzie—president of Kim’s Clothes Inc., a medium-sized manufacturer of women’s casual clothing—is worried. Her firm has been selling clothes to Russ Brothers Department S

> SafeCo can issue floating-rate debt at LIBOR + 1% or fixed-rate debt at 8%, but it would prefer to use fixed-rate debt. RiskyCo can issue floating- rate debt at LIBOR + 2% or fixed-rate debt at 8.8%, but it would prefer to use floating rate debt. Explain

> Zhao Automotive issues fixed-rate debt at a rate of 7.00%. Zhao agrees to an interest rate swap in which it pays LIBOR to Lee Financial and Lee pays 6.8% to Zhao. What is Zhao’s resulting net payment?

> Are liquidations likely to be more common for public utility, railroad, or industrial corporations? Why or why not?

> Would it be a sound rule to liquidate whenever the liquidation value is above the value of the corporation as a going concern? Discuss.

> Distinguish between operating mergers and financial mergers.

> Why do creditors usually accept a plan for financial rehabilitation rather than demand liquidation of the business?

> a. Informal restructuring; reorganization in bankruptcy b. Assignment; liquidation in bankruptcy; fairness; feasibility c. Absolute priority doctrine; relative priority doctrine d. Bankruptcy Reform Act of 1978; Chapter 11; Chapter 7 e. Priority of claim

> Why do liquidations usually result in losses for the creditors or the owners, or both? Would partial liquidation or liquidation over a period limit their losses? Explain.

> a. Derivatives b. Enterprise risk management c. Financial futures; forward contract d. Hedging; natural hedge; long hedge; short hedge; perfect hedge; symmetric hedge; asymmetric hedge e. Swap; structured note f. Commodity futures

> How can swaps be used to reduce the risks associated with debt contracts?

> Explain how the futures markets can be used to reduce interest rate risk and contracts?

> Explain how the EOQ inventory model can be modified and used to help determine the optimal size of a firm’s cash balances. Do you think the EOQ approach to cash management is more or less relevant today than it was in precomputer, preelectronic communica

> Explain briefly what the EOQ model is and how it can be used to help establish an optimal inventory policy. Is the EOQ concept consistent with just-in-time procedures for managing inventories?

> The Gentry Garden Center sells 90,000 bags of lawn fertilizer annually. The optimal safety stock (which is on hand initially) is 1,000 bags. Each bag costs the firm $1.50, inventory carrying cost is 20%, and the cost of placing an order with its supplier

> Barenbaum Industries projects that cash outlays of $4.5 million will occur uniformly throughout the year. Barenbaum plans to meet its cash requirements by periodically selling marketable securities from its portfolio. The firm’s marketable securities are

> Firm a wants to acquire Firm B. Firm B’s management agrees that the merger is a good idea. Might a tender offer be used? Why or why not?

> Indicate by a (+), (_), or (0) whether each of the following events would probably cause average annual inventory holdings to rise, fall, or be affected in an indeterminate manner: a. Our suppliers change from delivering by trainto air freight. ________

> a. Baumol model b. Total carrying cost; total ordering cost; total inventory costs c. Economic Ordering Quantity (EOQ); EOQ model; EOQ range d. Reorder point; safety stock e. Red-line method; two-bin method; computerized inventory control system f. Just-

> Explain how each of the following factors would probably affect a firm’s target cash balance if all other factors were held constant. a. The firm institutes a new billing procedure that better synchronizes its cash inflows and outflows. b. The firm devel

> Malone Feed and Supply Company buys on terms of 1/10, net 30, but it has not been taking discounts and has actually been paying in 60 rather than 30 days. Assume that the accounts payable are recorded at full cost, not net of discounts. Maloneâ&#12

> The Russ Fogler Company, a small manufacturer of cordless telephones, began operations on January 1. Its credit sales for the first 6 months of operations were as follows: Throughout this entire period, the firm’s credit customers maint

> Yonge Corporation must arrange financing for its working capital requirements for the coming year. Yonge can: (a) borrow from its bank on a simple interest basis (interest payable at the end of the loan) for 1 year at a 12% nominal rate; (b) borrow on a

> Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $2.5 million, Vinso

> The Boyd Corporation has annual credit sales of $1.6 million. Current expenses for the collection department are $35,000, bad-debt losses are 1.5%, and the days sales outstanding is 30 days. The firm is considering easing its collection efforts such that

> Gifts Galore Inc. borrowed $1.5 million from National City Bank. The loan was made at a simple annual interest rate of 9% a year for 3 months. A 20% compensating balance requirement raised the effective interest rate. a. The nominal annual rate on the lo

> Del Hawley, owner of Hawley’s Hardware, is negotiating with First City Bank for a 1-year loan of $50,000. First City has offered Hawley the alternatives listed below. Calculate the effective annual interest rate for each alternative. Which alternative ha

> Four economic classifications of mergers are: (1) horizontal, (2) vertical, (3) conglomerate, and (4) congeneric. Explain the significance of these terms in merger analysis with regard to (a) the likelihood of governmental intervention and (b) possibi

> Mary Jones recently obtained an equipment loan from a local bank. The loan is for $15,000 with a nominal interest rate of 11%. However, this is an installment loan, so the bank also charges add-on interest. Mary must make monthly payments on the loan, an

> Suncoast Boats Inc. estimates that, because of the seasonal nature of its business, it will require an additional $2 million of cash for the month of July. Suncoast Boats has the following four options available for raising the needed funds. 1. Establis

> What is the cash conversion cycle (CCC)? Why it better, other things held constant, to have a shorter rather than a longer CCC? Suppose you know a company’s annual sales, average inventories, average accounts receivable, average accounts payable, and ann

> Define the terms aggressive and conservative when applied to financing, give examples of each, and then discuss the pros and cons of each approach. Would you expect to find entrenched firms in monopolistic (or oligopolistic) industries leaning more towar

> What are some advantages of matching the maturities of claims against assets with the lives of the assets financed by those claims? Is it feasible for a firm to match perfectly the maturities of all assets and claims against assets? Why might a firm deli

> Differentiate between free and costly trade credit. What is the formula for determining the nominal annual cost rate associated with a credit policy? What is the formula for the effective annual cost rate? How would these cost rates be affected if a firm

> What is a cash budget, and how is this statement used by a business? How is the cash budget affected by the CCC? By credit policy?

> Lewis Securities Inc. has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other information from several online data services and then either displays the information o

> Define each of the following terms: a. Cash discounts b. Seasonal dating c. Aging schedule; days sales outstanding (DSO) d. Payments pattern approach; uncollected balances schedule e. Simple interest; discount interest; add-on interest

> Indicate by a (1), (2), or (0) whether each of the following events would most likely cause accounts receivable (AR), sales, and profits to increase, decrease, or be affected in an indeterminate manner: AR Sales Profits The firm tightens its credit s

> a. Synergy; merger b. Horizontal merger; vertical merger; congeneric merger; conglomerate merger c. Friendly merger; hostile merger; defensive merger; tender offer; target company; breakup value; acquiring company d. Operating merger; financial merger e.

> What are the two principal reasons for holding cash? Can a firm estimate its target cash balance by summing the cash held to satisfy each of the two reasons?

> Discuss this statement: “Firms can control their accruals within fairly wide limits.”

2.99

See Answer