Question

Dell Corp. is considering acquiring a startup company Asus Corp. Based on last year's financial statements, Asus Corp reported obtaining a free cash flow (FCF) of $ 400 million, and is expected to experience a constant growth of 5% every year. The acquisition will be funded with 60% equity, and the remainder with debt with a fixed interest of 12% per year. There is a market return of 15%, a government bond interest rate of 6%, and an Asus Corp beta amount of 0.8. Corporate tax is 25%. Calculate what is the fair value of Asus Corp as the target company to be acquired by Dell Corp.

Answer 1

Calculation of the WACC of Asus Corp.:-

Cost of debt after tax = interest rate * ( 1 - tax rate ) = 12% * ( 1- 0.25) = 9%

Cost of equity = Rf + Beta ( Rm - Rf) = 0.06 + 0.8 * ( 0.15 -0.06) = 0.06 + 0.072 = 0.132 = 13.2%

WACC= Cost of debt after tax* weight of debt + cost of equity * Weight of equity

WACC = 9% * 0.40 + 13.2% * 0.60 = 11.52%

fair value of Asus Corp as the target company to be acquired by Dell Corp using free cash flows   = FCF0(1+g) / (WACC - g)

Here FCF0 = Free cash flows of last year =$ 400 million

g= growth rate of cash flows = 5%

WACC = 11.52%

fair value of Asus Corp = 400m * ( 1.05) / ( 0.1152 - 0.05) =$ 6441.7178 million

fair value of Asus Corp as the target company to be acquired by Dell Corp = $ 6441.7178 million