Data Given:
2017 
2018 
2019 
2020 

Net sales 
$500 
$600 
$700 
$760 

Selling and administrative expense 
60 
70 
80 
90 

Interest 
30 
40 
45 
60 

Tax rate of ACC before the merger 
30% 

Tax rate after merger 
35% 

Cost of goods sold as a % of sales 
65% 

Debt ratio (percent financed with debt) before the merger 
30% 

Cost of debt before merger 
9% 

Debt ratio (percent financed with debt) after the merger 
40% 

Cost of debt after merger 
10% 

Beta of ACC 
1.40 

Riskfree rate 
7% 

Market risk premium 
6.5% 

Terminal growth rate of free cash flow 
6.0% 

Premerger debt (in thousands) 
$ 400 

1. What is the levered cost of equity at old capital structure?
2. What is the unlevered cost of equity?
Before we can proceed with this problem, we must generate pro forma income statements for ACC's operations after the proposed merger so we can calculate free cash flow and interest tax shields. 

Fill in the chart
2017 
2018 
2019 
2020 
2021 

Sales 

Cost of Goods Sold (incl. depreciation) 

Gross Profit 

Selling/admin. costs 

EBIT 

Interest 

EBT 

Taxes 

Net Income 

EBIT 

NOPAT 

Investment in net operating capital 

FCF 
We must determine the tax shields. 

From this point, we can derive horizon value from the basic DCF framework. 

The tax shield is the interest multiplied by the postmerger tax rate. 

2017 
2018 
2019 
2020 
2021 

Interest 
0.0 
0.0 
0.0 
0.0 
0.0 

Tax shield 

HVTS _{2020} 
= 
TS_{2021} 
* 
(1+g) 
/ 
(r_{sU}_{)} 
 
g) 

HVTS _{2020} 
= 
* 
/ 
 

HVTS _{2020} 
= 
/ 

HVTS _{2020} 
= 

To calculate the value of the tax shields add the horizon value of the tax shields to the 2021 tax shield 

to get the total tax shield cash flow in 2021. In the other years the total TS cash flow is just the annual TS 

Then find the NPV of this stream of tax shields at the unlevered cost of equity. 

2017 
2018 
2019 
2020 
2021 

Total TS Cash Flows 

NPV of TS Cash Flows 
This is the value of all of the tax shields. 
To calculate the unlevered value of operations you need the unlevered horizon value and the 

the annual free cash flows. 

To calculate the unlevered horizon value, we just need the free cash flow for 2021 

HVUL _{2021} 
= 
FCF_{2021} 
* 
(1+g) 
/ 
(r_{sU} 
 
g) 

HVUL _{2021} 
= 
* 
/ 
 

HVUL _{2021} 
= 
/ 

HVUL _{2021} 
= 

To calculate the unlevered value of operations, add the unlevered horizon value to the free cash flow 

in 2021 to get the total unlevered cash flow in 2021. In the other years the unlevered cash flow is 

just the annual free cash flow. The unlevered value of operations is the NPV of the unlevered 

cash flows at the unlevered cost of equity. 

Year 
2017 
2018 
2019 
2020 
2021 

Total unlevered CFs 

NPV of unlevered CFs 
This is the unlevered value of operations 

The value of operations is the value of the interest tax shields plus the unlevered value of operations
V_{TS} 
+ 
V_{unlevered} 

V_{ops} 
= 
+ 

V_{ops} 
= 
To find the value of ACC to Wansley's shareholders take the value of operations, add in any nonoperating assets (there are non for ACC) and subtract off the debt. 

V_{ops} 
= 

Debt 
= 

Equity 
= 
Risk free rate  7.00% 
Beta (Considering it Company's levered beta)  1.4 
market Premium  6.50% 
levered cost of equity at old capital structure  16.10% 
levered beta = Unlevered Beta * [1 + (1  Tax Rate) * Debt / Equity ]
Hence Unlevered Beta = levered Beta / [1 + (1  Tax Rate) * Debt / Equity ] = 1.1
Unlevered cost of equity at old capital structure = 14%
2017  2018  2019  2020  2021  
Sales  500  600  700  760  
Cost of Goods Sold (incl. depreciation)  325  390  455  494  
Gross Profit  175  210  245  266  
Selling/admin. costs  60  70  80  90  
EBIT  115  140  165  176  
Interest  30  40  45  60  
EBT  85  100  120  116  
Taxes  29.75  35  42  40.6  
Net Income  55  65  78  75  
EBIT  115  140  165  176  
NOPAT  74.75  91  107.25  114.4  
Investment in net operating capital  NA  NA  NA  NA  
FCF  74.75  91  107.25  114.4 
Financial for Year 2021 is not given.
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