CCMA – HW 1

D E
WACC= r d ( 1−t c ) + r
1. D+ E D+E e
We know that the cost of debt is lower than the cost of equity, i.e. r D < rE. Clearly then, rD (1-tc) < rE
Since WACC is the weighted average of the after-tax cost of debt and the cost of equity, we can draw the following conclusion. Increasing D puts
greater weight on the lower cost debt capital and therefore lowers WACC, thereby increasing firm value and equity value. If financing a firm with
greater debt increases firm value and equity value, why don’t we find all firms financed with 100% debt?

Ans: We can take the leverage of debt due to tax shields with Weighted average cost of capital, however beyond the ideal debt/equity ratio, there will
be greater risk with debt as the tax shields are used to the maximum, and the cost of equity will climb along with more debt until the cost of capital
exceeds the firms EBIT as shown in the PIC1. If we obtain 100 percent financing, probability of bankruptcy increases and present values due to
financial distress will rise, raising the equity risk premium and providing no advantage to the firm's equity investors.

PIC1
2.
a. Calculate the weighted average costs of capital for Exxon and Mobil.
EXOn 1999 Mobil 1999
FCF(bil) 11.5 3.5
G@nominal 3% 3%
(D/(D+E)) 30% 30%
B.E 0.85 0.75
MRP(rm-rf) 7% 7%
Rating AAA AA
rf 5.60% 5.60%
Spread 1.60% 1.90%
Tax.Rate 35% 35%
(E/(D+E)) 70% 8.05 70%
Ke rf+B(rm-rf) Ke rf+B(rm-rf)
11.55% 10.85%
kd (Rf+CreditSpread)*(1-Tr)) kd (Rf+CreditSpread)*(1-Tr))
4.68% 4.88%
D/E 0.428571429 0.428571429
WACC E/(E+D)*ke+(D(1-Tc)/(D+E))*kd
9.49% 9.06%

WACC for Exon: 9.48% Mobil:9.05%

b. Calculate the enterprise values of Exxon and Mobil year ending 1998. Assume that neither Exxon nor Mobil had any additional cash or
liquid securities outstanding on their balance sheets at that time.
 Values from Operations +Cash
value of the firm +marketable securities

Exxon Mobil
Forecast period 10.50333823 3.209316186
Terminal 182.5396825 59.51300041
162.8689171 53.33798656
Value 162.8689171 53.33798656

Total Value: 216.2069037

c. After the merger, the merged firm ExxonMobil was not planning to alter the business mix, i.e. the erstwhile stand-alone entities were
expected to continue their lines of business as before the merger. What would be asset beta (or unlevered beta) of the merged entity after
the merger? You can assume the debt beta to be equal to 0.2 for Exxon and 0.25 for Mobil.
We can identify the Bu from the following formula:

E l  D 1  t  D
u 
E  D 1  t 

debt beta to be
equal to 0.2 for
Exxon and 0.25  Total Value
for Mobil =216.2069037

Eq 114.008242 Total Value*(E/(D+E)) 37.33659059

Debt 48.86067513 Total Values*(D/(D+E)) 16.00139597

Bu 0.708379888 Ebl+D(1-t)Bd/(E+D(1-t) 0.630167598
(BuExon*VEx)/total
Asset Beta of value+(BuMo*VMob)/Tot
Merged Firm 0.689085009 al Value
 d. The merged entity anticipates that it would be able to keep the same financing mix after the merger (i.e. D/(D+E)=0.3). Exxon-Mobil also
would have a AAA Bond rating. What would the cost of capital for the merged entity?
BA (1/1+D/E)*BE
BeE BA*(1+D/E)
0.984407156
Ke rf+Be(MRP)
0.124908501

0.00312 0.087435951
 WACC 0.09

e. Assume that by reducing duplication in assets, Exxonmobil would be able to increase the unlevered free cash flows in the year ending 1999
by $2 billion. Moreover, given their combined strengths, they would be able to grow their free cash flows perpetually at 4% per year. What
would be the firm value of the merged entity?
Asset values 2 billoon
TFCF(1999) 17
FCF(20000 FCF2000*(1+G)/(wacc-g) G=4%
349.7115528
PV 309.633567 Total

f. What are the anticipated synergies from the merger as estimated year ending 1998?
VAT=329.63
VA=162.8689171
VT= 53.33798656
Synergies VAT-VA-VT
93.42666335

3.
1. Calculate the synergies that firms 1 and 2 can achieve by acquiring firm 3. No need to categorize the synergies into various sources. All I am
interested is the magnitude of the synergies.
FCF0 FCF1 FCF2 FCF3 FCF4 FCF5 FCF6 FCF7 TV
3502.50 4027.88 4632.06 5326.86 6125.89 7044.78 8101.50 9316.72 9875.72
2994.10 3443.22 3959.70 4553.65 5236.70 6022.20 6925.54 7964.37 8442.23
1604.20 1844.83 2121.55 2439.79 2805.76 3226.62 3710.61 4267.20 4523.24

D/E 1 0.5 0
Ba 0.8 0.8 1
kd 6% 5.50%
mrp 8% 8% 8%
rf 6% 6% 6%
tC 40% 40% 40%
g 6% 6% 6%
Be Ba*(1+D/E)
1.6 1.2 1
Ke rf+be(MRP)
19% 16% 14%

D/(D+E)*Kd+E/
WACC (D+E)*Ke
D/E/(1+D/
E)*kd+(1/(1+D/
E)*ke)
WACC 0.12 0.12 0.14
FCF/ FCF/ FCF/ FCF/ FCF/ FCF8*(1+ TV/
(1+WACC)^ (1+WACC) (1+WACC (1+WACC) (1+WACC) g)/(Wacc- (1+wac
FCF/(1+WACC)^1 2 FCF/(1+WACC)^3 ^4 )^5 ^6 ^7 g) c)^8
154308.1 60570.
3583.52 3666.41 3751.22 3837.99 3926.77 4017.61 4110.54 7 12
135436.8 47478.
3067.91 3143.53 3221.03 3300.43 3381.79 3465.15 3550.57 0 60
19820.
3533.22 3564.22 3595.48 3627.02 3658.84 4207.66 4244.57 56540.45 77
DCF 87464.18
DCF 70609.00
DCF 46251.78

0 1 2 3 4 5 6 7 8
2819.6
Total Units 1000 1150 1322.5 1520.875 1749.006 2011.357 2313.061 2660.02 21
532.3062 15419.
ICICI 35% 402.5 462.875 5 612.1522 703.975 809.5713 931.007 80
358.09608 374.8544 6052.6
DCF 54 366.3794468 162 383.5254 392.397 401.4738 410.7606 89
PVICICI 8740.175329

380.2187 11308.
HDFC 25% 287.5 330.625 5 437.2516 502.8393 578.2652 665.005 64
255.78291 267.7531 4438.9
DCF 81 261.6996049 544 273.9467 280.2836 286.767 293.4004 47
PVHDFC 6358.579944

7049.0
Madhura 20% 230 264.5 304.175 349.8013 402.2714 462.6122 532.004 53
204.62633 214.2025 2471.1
DCF 45 209.3596839 236 219.1574 224.2269 229.4136 234.7203 09
PVMadhura 4006.815969

22412.
V13 60% 690 793.5 912.525 1049.404 1206.814 1387.836 1596.012 08
613.87900 642.6075 8797.3
DCF 36 628.0790517 707 657.4722 672.6806 688.2408 704.161 47
PV13 13404.46713

11308.
V2,1+3 20% 230 264.5 304.175 349.8013 402.2714 462.6122 532.004 64
 204.62633 214.2025 4438.9
DCF 45 209.3596839 236 219.1574 224.2269 229.4136 234.7203 47
PV2,1+3 5974.653263

21939.
V23 50% 575 661.25 760.4375 874.5031 1005.679 1156.53 1330.01 41
511.56583 535.5063 8611.8
DCF 63 523.3992097 089 547.8935 560.5672 573.534 586.8008 12
PV23 12451.07894

15419.
V1,2+3 30% 345 396.75 456.2625 524.7019 603.4072 693.9182 798.006 8
306.93950 321.3037 6052.6
DCF 18 314.0395258 853 328.7361 336.3403 344.1204 352.0805 89
PV1,2+3 8356.248648

opportuni v1-
Value added(1+3) V13-V1,2+3-V3 Synergy V13-v3-v1 ty cost v1,V2+3
1041.402513 657.4758319 383.9267
opportuni v2-
value added(2+3) [v23-v2,1+3-v3] Synergy v23-v3-v2 ty cost v2,1+3
2469.60971 2085.68303 383.9267

2. Estimate the maximum premium that firm 1 and firm 2 can pay to acquire firm 3 without their shareholders losing out in the bargain.
4.
To analyze the merger, do the following:
(I) Status Quo valuation of Indian Airlines:
At the time of the merger (i.e. year 0), Indian Airlines had the following characteristics:
Estimate the enterprise value (or firm value) of Indian Airlines.

Current
valuation of Indian Year(Mi
Airlines Current Year l) Y1 Y2 Y3 Y4 Y5 Y6
13828.7 14658. 15537. 16470.27 17458. 18331.
Revenue($Billion) 13.046 13046 6 49 99 44 49 42
Operating 414.862 439.75 466.13 494.1082 523.75 549.94
Profit(mil) 391.38 391.38 8 46 98 33 47 25
565.73 599.6765 635.65 635.65
Capex(mil) 475 475 503.5 533.71 26 56 71 71
517.97 549.05 582.0018 616.92 635.65
Depreciation(mil) 461 461 488.66 96 84 79 2 71
NWC(15% of 2074.31 2198.7 2330.6 2470.541 2618.7 2618.7
Revenues)(billion) 1.9569 1956.9 4 73 99 16 74 74
Growth Rate 6% 6% 6% 6% 6% 6% 6% 5%
Tax Rate 36% 36%
D/D+E 10% 10% 10% 10% 10% 10% 10%
BetaLevered 1.15 1.15 1.15 1.15 1.15 1.15 1.15 1.00
kd 7.81% 7.81% 7.81% 7.81% 7.81% 6.25%
mrp 6% 6% 6% 6% 6% 6%
rf 6% 6% 6% 6% 6% 6%

250.483 265.512 281.44 298.32 316.2292 335.20 351.96

NOPAT 250.4832 2 2 29 95 69 3 32
124.45 131.92 139.8419 148.23
Changes in NWC 1956.9 117.414 88 64 53 25 0
depreciation 461 461 488.66 517.97 549.05 582.0018 616.92 635.65
 96 84 79 2 71
565.73 599.6765 635.65 635.65
capex 475 475 503.5 533.71 26 56 71 71

D/E 11.11% 11.11%

0.1 D/D+E
D/E/(1+D/E)
0.1(1+D/E) D/E

0.1+0.1D/E D/E
0.9D/E= 0.1 0.1
D/E= 11.11% 11.11%

BA=
LeaverdBeta/(1+D/
E) 1.035 0.9
11.4000 Rf+B(R
Ri 12.2100% % M-Rf)
10.7598 0.0000
WACC 11.4888% % %

NOPAT+Dep
re-
ChangeinNW
UFCF= C-Capex
-
1720.41 133.258 141.25 149.72 158.7126 168.23 6110.6
UFCF 7 2 37 89 39 54 42
113.64 108.04 102.7273 97.669 3309.7
DCF 119.526 15 67 12 82 32
PV_IA 3851.343835
Enter Price Value =3851.34
(II) Value of Control at Indian Airlines:
(a) Calculate the enterprise value (or firm value) of Indian Airlines optimally managed.
(b) Find the value of control at Indian Airlines defined as Enterprise value of Indian Airlines optimally managed – Status Quo value of
Indian Airlines.

Current Current
Control of Indian Airlines Year Year(Mil) Y1 Y2 Y3 Y4 Y5 Y6
Revenue($Billion) 13.046 13046 14350.6 15785.66 17364.226 19100.6486 21010.71346 22061.24913
Operating Profit(mil)
*10% 391.38 391.38 430.518 473.5698 520.92678 573.019458 630.3214038 661.837474
Capex(mil) *10% 475 475 522.5 574.75 632.225 695.4475 764.99225 764.99225

Depreciation(mil) *10% 461 461 507.1 557.81 613.591 674.9501 742.44511 764.99225
NWC(15% of Revenues)
(billion) 1.9569 1956.9 2152.59 2367.849 2604.6339 2865.09729 3151.607019 3151.607019
Growth Rate 10% 10% 10% 10% 10% 10% 10% 5%
Tax Rate 36% 36%
D/D+E 20% 20% 20% 20% 20% 20% 20%
BetaLevered 1.15 1.15 1.15 1.15 1.15 1.15 1.15 1.00
kd 8.20% 8.20% 8.20% 8.20% 8.20% 6.50%
mrp 6% 6% 6% 6% 6% 6%
rf 6% 6% 6% 6% 6% 6%
BetaDebt 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2
NOPAT 250.4832 250.4832 275.53152 303.084672 333.3931392 366.7324531 403.4056984 423.5759834
Changes in NWC 1956.9 195.69 215.259 236.7849 260.46339 286.509729 0
depreciation 461 461 507.1 557.81 613.591 674.9501 742.44511 764.99225
capex 475 475 522.5 574.75 632.225 695.4475 764.99225 764.99225

D/E 25.00% 25.00%

0.2 D/D+E
D/E/
(1+D/E)
 0.2*(1+D/E) D/E

0.2+0.2D/E D/E
0.8D/E= 0.2 0.2
D/E= 25.00% 25.00%
(BeL+(D/
E*(1-
tc)*Bd))/
((1+D/
E)*(1-Tc)) 6th year

BA= 1.0189655 0.889655

LeaverdBeta/(1+D/E) 17 172
11.3379 Rf+B(RM-
Ri 12.1138% % Rf)
10.1199
WACC 10.7406% % 0.0000%

NOPAT+De
pre-
ChangeinN
UFCF= WC-Capex Y1 Y2 Y3 Y4 Y5 Y6
-
1720.416
UFCF 8 64.44152 70.885672 77.9742392 85.77166312 94.34882943 8273.057574
58.191394
DCF 97 57.80221033 57.41562856 57.03163226 56.65020412 4639.488856
4926.5799
PV_COIA 26

Optimally managed = PV_COIA- PV_IA = 4926.58 - 3851.34 = 1075.24

value of control at Indian Airlines = 4926.579926

(III) Value of Air India as a Stand Alone Firm

 Current
Year(Mil
valuation ofAir India Current Year ) Y1 Y2 Y3 Y4 Y5 Y6
Revenue($Billion) 25.484 25484 27013.04 28633.82 30351.85 32172.9628 34103.34 35808.51

Operating Profit(mil) 2987 2987 3166.22 3356.193 3557.565 3771.01868 3997.28 4197.144
Capex(mil) 729 729 772.74 819.1044 868.2507 920.345704 975.5664 975.5664
Depreciation(mil) 545 545 577.7 612.362 649.1037 688.049943 729.3329 975.5664
NWC(15% of Revenues)
(billion) 3.8226 3822.6 4051.956 4295.073 4552.778 4825.94443 5115.501 5115.501
Growth Rate 10% 10% 10% 10% 10% 10% 10% 5%
Tax Rate 36% 36%
D/D+E 10% 10% 10% 10% 10% 10% 10% 20%
BetaLevered 1.25 1.25 1.25 1.25 1.25 1.25 1.25 1.00
kd 7.81% 7.81% 7.81% 7.81% 7.81% 6.25%
mrp 6% 6% 6% 6% 6% 6%
rf 6% 6% 6% 6% 6% 6%

NOPAT 1911.68 1911.68 2026.381 2147.964 2276.841 2413.45195 2558.259 2686.172

Changes in NWC 3822.6 229.356 243.1174 257.7044 273.166666 289.5567 0
depre 545 545 577.7 612.362 649.1037 688.049943 729.3329 975.5664
capex 729 729 772.74 819.1044 868.2507 920.345704 975.5664 975.5664

D/E 11.11% 25.00% D/E 25.00% 25.00%

0.1 D/D+E 0.2 D/D+E
D/E/(1+D/
D/E/(1+D/E) E)
0.1(1+D/E) D/E 0.2*(1+D/E) D/E

0.1+0.1D/E D/E 0.2+0.2D/E D/E

0.9D/E= 0.1 0.8D/E= 0.2
D/E= 11.11% 25.00% D/E= 25.00% 25.00%
 BA=
LeaverdBeta/(1+D/E) 1.125 0.80
Rf+B(RM-
Ri 12.7500% 10.80% Rf)
WACC 11.9748% 9.6397% 0.0000%

NOPAT+Depre-
ChangeinNWC-
UFCF= Capex
UFCF -2094.92 1601.985 1698.104 1799.99 1907.98953 2022.469 57895.63
DCF 1430.665 1354.326 1282.061 1213.65202 1148.893 33330.3
PV_AI 39759.89887
Value of Air India as a Stand Alone Firm : 39759.89887

(IV) Value of Synergies between Air India and Indian Airlines

Current
Synergies AIIA Current Year Year(Mil) Y1 Y2 Y3 Y4 Y5 Y6
47046.093 51985.933 57444.456 63476.123 66649.930
Revenue($Billion) 38.53 38530 42575.65 25 04 01 89 09
Operating 4335.5864 4890.8230 5504.3594 6182.3171 6931.4604
Profit(mil) 3378.38 3833.1099 4 16 32 73 76 7378.0335
1624.4760 1795.0460 1983.5259 1983.5259
Capex(mil) 1204 1204 1330.42 1470.1141 81 69 06 06
1228.3511 1357.3280 1499.8474 1657.3314 1983.5259
Depreciation(mil) 1006 1006 1111.63 5 21 63 47 06
NWC(15% of 7056.9139 7797.8899 8616.6684 9521.4185 9521.4185
Revenues)(billion) 5.7795 5779.5 6386.3475 88 56 02 84 84
Growth Rate 10.50% 10.50% 10.50% 10.50% 10.50% 10.50% 10.50% 5%
Tax Rate 36% 36% 36% 36% 36% 36% 36% 36%
D/D+E 12% 12% 12% 12% 12% 12% 12% 20%
 BetaLevered 1.25 1.25 1.25 1.25 1.25 1.25 1.25 1.00
kd 7.81% 7.81% 7.81% 7.81% 7.81% 6.25%
mrp 6% 6% 6% 6% 6% 6%
rf 6% 6% 6% 6% 6% 6%
Cost Savings(Pre
Tax) 100 100 100 100 100 100 100
2453.1903 2774.7753 3130.1267 3522.7900 3956.6829 4436.1347 4721.9414
NOPAT 2162.1632 36 21 3 37 91 05 4
670.56648 740.97596 818.77844 904.75018
Changes in NWC 0 606.8475 75 87 54 22 0
1228.3511 1357.3280 1499.8474 1657.3314 1983.5259
depre 1006 1006 1111.63 5 21 63 47 06
1624.4760 1795.0460 1983.5259 1983.5259
capex 1204 1204 1330.42 1470.1141 81 69 06 06

D/E 13.33% 25.00% D/E 25.00% 25.00%

0.12 D/D+E 0.2 D/D+E
D/E/(1+D/
D/E/(1+D/E) E)
0.2*(1+D/
0.12(1+D/E) D/E E) D/E

0.12+0.12D/E D/E 0.2+0.2D/E D/E

0.11D/E= 0.12 0.8D/E= 0.2
D/E= 13.33% 25.00% D/E= 25.00% 25.00%

BA=
LeaverdBeta/(1+D
/E) 1.102941176 0.80
Rf+B(RM-
Ri 13.5910% 12.07% Rf)
WACC 12.58% 10.66% 0.0000%
 NOPAT+Depre-
ChangeinNWC-
UFCF= Capex
2255.1903 1949.1378 2217.7972 2514.6660 2842.7059 3205.1900 83462.706
UFCF 36 21 93 08 39 63 16
1730.2623 1747.6750 1759.0920 1765.2638 1766.8549 45600.461
DCF 97 67 81 19 25 66
PV_IAIA 54369.60995

(V1/
(V1+V2)*BA1 +
(v2/(V1+V2)*BA
BA1,2 2
BA1,2 1.12 0.81
5th year 6th year
BE 1.27 1.01

VA12-VA1-VA2 18369.71751

Value of Synergies between Air India and Indian Airlines: 18369.71751

5. Develop a detailed and comprehensive framework for evaluating synergies in mergers and acquisitions. You can only use 2 printed pages to
display the final framework.