VolWorld Communications Inc., a large telecommunications company

| June 13, 2018

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 thousands of dollars, with a year end of December 31): 2014 2015 2016 2017 2018 2019 Net sales 450 518 555 600 643 Selling and administrative expense 45 53 60 68 73 Interest 40 45 47 52 54 Total net operating capital 800 850 930 1,005 1,075 1,150 Tax rate after merger: 35% Cost of goods sold as a percent of sales: 65% BCC’s pre-merger beta: 1.40 Risk-free rate: 6% Market risk premium: 4% Terminal growth rate of free cash flows: 7%If the acquisition is made, it will occur on January 1, 2015. All cash flows shown in the income statements are assumed to occur at the end of the year. BCC currently has a capital structure of 40% debt, which costs 10%, but over the next 4 years VolWorld would increase that to 50%, and the target capital structure would be reached by the start of 2019. BCC, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. BCC’s current market-determined beta is 1.4. The cost of goods sold is expected to be 65% of sales.a. What is the unlevered cost of equity for BCC?b. What are the free cash flows and interest tax shields for the first five years?c. What is BCC’s horizon value of interest tax shields and unlevered horizon value?d. What is the value of BCC’s equity to VolWorld’s shareholders if BCC has $300,000 in debt outstanding now?

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