MERGER ANALYSIS Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is a publicly traded company, and its current beta is 1.30. Vaccaro has been barely profitable, so it has paid an average of only 20% in taxes during the last several years. In addition, it uses little debt, having a debt ratio of just 25%.
If the acquisition were made, Apilado would operate Vaccaro as a separate, wholly owned subsidiary. Apilado would pay taxes on a consolidated basis, and the tax rate would therefore increase to 35%. Apilado also would increase the debt capitalization in the Vaccaro subsidiary to 40% of assets, which would increase its beta to 1.47. Apilado's acquisition department estimates that Vaccaro, if acquired, would produce the following cash flows to Apilado's shareholders (in millions of dollars):
Year | Cash Flows |
1 | $1.30 |
2 | 1.50 |
3 | 1.75 |
4 | 2.00 |
5 and beyond | Constant growth at 6% |
These cash flows include all acquisition effects. Apilado's cost of equity is 14%, its beta is 1.0, and its cost of debt is 10%. The risk-free rate is 8%.
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