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What is the Value of a Smaller Chain

Brau Auto, a national autoparts chain, is considering purchasing a smaller chain, South Georgia Parts (SGP). Brau's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:

Year 1 2 3 4
Free cash flow $1 $3 $3 $7
Unlevered horizon value 75
Tax shield 1 1 2 3
Horizon value of tax shield 32

Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Brau?

Solution Preview

The value of SGP to Brau will be the present value of free cash flows(unlevered) + the present value of interest tax shield.
Since the free cash flows are unlevered (implying that these are equity flows), we would need to discount these cash flows at the unlevered cost of equity.

We calculate ...

Solution Summary

The solution explains how to calculate the value of SGP to Brau in 205 words with explained calculations.

$2.19