Business Case Study: Computech's Case

5155 Words 21 Pages
Register to read the introduction… Since interest expense has already been considered, the cash flows are equity flows, so they must be discounted using the cost of equity rather than the WACC. Also, the discount rate must reflect the riskiness of the flows, and these cash flows have CCI's business risk, not CompuTech’s business risk, plus its financial risk because interest has been deducted. Though, that the risk of the CCI Division is not the same as CCI’s risk if it operated independently, because the merger would lead to a change in CCI's leverage and its tax …show more content…
Note that the pre-merger tax rate and debt to equity ratio are used to unlever the beta. The resulting beta, 1.48, is the inherent beta of CCI's assets—if CCI had zero debt, and hence were unlevered, its beta would be 1.48. Next, this unlevered beta must be "relevered" to reflect the fact that the assets will be operated by CompuTech and will be financed with a debt ratio of 25 percent and subject to a tax rate of 40 percent: bL = bU[1 + (1 — T)(D/S] = 1.48[1+(0.6)(0.25/0.75)] = 1.48(1.2) = 1.78.
Thus, to obtain the required rate of return on equity, note that kRF = 6.5% and RPM = 5%. Thus, CCI Division's required rate of return on equity, which is the appropriate discount rate to apply to the merger cash flows, is 15.41%: ks(CCI) = kRF + (RPm)bCCI = 6.5% + (5%) 1.78 = 15.41%.
Although the discount rate was calculated to two decimal places, our confidence in its accuracy is low. First, CCI's market beta of 1.60 is merely an estimate of the true beta. Second, historical betas are not particularly good estimates of future market risk. Third, Hamada's equation requires all of the assumptions of the CAPM and of the Modigliani and Miller model, including no financial distress or agency costs. Thus, it can provide only a rough estimate of the effect of the acquisition on CCI's market risk. Finally, it is difficult to estimate the market risk premium at any point in
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That tactic rarely works. The only other thing we can think of is to attempt to put together a leveraged managerial buyout. That might work, especially if the present management is regarded as being especially competent, and if the management would stay with the firm if a LBO occurs but resign if a hostile takeover occurs, this tactic works best if "people are the only asset," as is often true of service companies such as those in the securities business. An example of this was Mellon Bank's acquisition of Boston Company, a money management firm, whose top managers left to start a competing company and took most of their clients with

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