Financial Mathematics

Chapter 21 Question 6

2015 2016 2017 2018

Net Sales $421 $504 $549 $608

Selling and administrative expense 48 55 60 69

Interest 18 21 24 27

cost of goods sold as a percent of sales 70%

Beta after merger 1.507

Risk-free rate 6%

Market risk premium 5%

Continuing growth rate of cash flow available to TransWorld 5%

What is the appropriate discount rate for valuing the acquisition?

Appropriate discount rate would be:

Risk free rate + market risk premium x Beta

6% + ( 5 x 1.507) = 13.535

	2015	2016	2017	2018
Net sales	$421	$504	$549	$608
Less the selling and administrative expenses	48	55	60	69
Less interest	18	21	24	27
Earnings before tax	355	428	465	512
Less tax 35% after merger	124.25	149.8	162.75	179.2
Net Income	230.75	278.2	302.25	332.8

Continuing Value = (Net income (2018) + (1+ growth rate) / (cost of equity – growth rate)

The continuing value = 332.8 + (1 + 5%) / (13.535 -5%)

= 3911.54

		2015	2016	2017	2018
Net sales		$421	$504	$549	$608
Less the selling and administrative expenses		48	55	60	69
Less interest		18	21	24	27
Earnings before tax		355	428	465	512
Less tax 35% after merger		124.25	149.8	162.75	179.2
Net income		230.75	278.2	302.25	332.8
Terminal value of cash flow		0	0	0	3911.54
Net cash flow to transworld		230.75	278.2	302.25	4244.34
Present value		202.58	215.67	206.53	2454.412
Value of GCC to Transworld	3179.19