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Brandy’s marries Macintosh – Calculate the market-required rate

Long Q.1: Brandy’s marries MacintoshMacintosh SuperFood Ltd. operates a chain of 200 supermarkets in the Mid-West. Thecompany had had a lackluster record and, since the death of its founder in late 2000, it had beenregarded as a prime target for a takeover bid. In anticipation of a bid, Macintosh’s share pricemoved up from $ 4 in November to a 12-month high of $ 5 on December 31, 2002 despite thefact that the stock market index as a whole was largely unchanged.Almost nobody anticipated a bid coming from Brandy’s, a large operator of chain ofsupermarkets in the Mid-West and North-East; Brandy’s management had, however, beencontemplating a merger with Macintosh for some time. They believed that better managementand inventory control in Macintosh’s business, as well as closing of 15 Macintosh’s marginalstores, could result in eliminating 450 employees and in cost savings worth $10 million perannum in perpetuity.Brandy’s offer of one Brandy’s share (trading at $10 on the day of the offer) for everyMacintosh share stunned the Markets when it was announced at 5 PM on December 31, 2002.Brandy’s plans to issue 15 million new shares to replace the Macintosh’s 15 million shares.Macintosh’s CEO and Brandy’s CEO met on the evening of Jan.2. During that meeting theyagreed to a “small” addition: The deal will be consummated on 1/ 02/04 [i.e., in one year]; atthat time, “every stockholder of Macintosh will have an option to exchange her Macintosh sharefor one share of Brandy’s or to get $10 in cash”. With this addition both CEOs agreed to mergetheir firms on 1/ 02/04. DATAMacintosh’s Balance Sheet on the 12/31/2002[Book Values].LiabilitiesAssetsBank debt$ 0Cash$ 10 million8% bond due on 12/31/2015 1,$ 15 millionFixed assets$ 35 million2,3Stockholders equity$ 30 millionTotal liabilities$ 45 millionTotal assets$ 45 millionNotes:1. The yield to maturity on Macintosh’s debt (for all maturities) currently is 8 percent.2. Macintosh has 15 million shares outstanding, with market price of $5 a share.3. Macintosh’s equity beta is estimated at 1.25, the market risk premium is 8 percent, and the Treasury bill rate is 4 percent. Brandy’s Balance Sheet on the 12/31/2002 [Book Values].LiabilitiesAssetsBank debt$ 0Cash$ 50 million10% bond due on 12/31/2012 1, $ 500 millionFixed assets$ 500 million2,3Stockholders equity$ 50 millionTotal liabilities$ 550 millionTotal assets$ 550 millionNotes:1. The yield to maturity on Brandy’s debt (for all maturities) currently is 10 percent.2. Brandy’s has 50 million shares outstanding, with market price of $10 a share.3. Brandy’s equity beta is estimated at 1.5, the market risk premium is 8 percent, and the Treasury bill rate is 4 percent. ii Q 1.1 (5 points) Calculate the market-required rate of return on Macintosh’s and on Brandy’sequity and the WACC for the two firms. Q 1.2 (5 points)Use the above data to calculate the capitalized value of future savings due to “bettermanagement and inventory control in Macintosh’s business as well as closing of 15Macintosh’s marginal stores”. [Hint: think what discount rate should you use. If you cannotchoose, assume the discount rate to be 12.5%]. iii Q.1.3 (5 points)Present the Balance Sheets of Macintosh and Brandy’s in market values. Calculate the D / Efor each firm and compare their capital structures. iv Q.1.4 (10 points)Calculate the Market valuation of the two firms on 12/31/02. Explain why Brandy’s stock betais higher than Macintosh’s. Then comment on following statements:1.“Macintosh could increase its value if it would borrow more “2.“Macintosh’s relatively small debt burden was a reason for its take-over””. Q.1 .5 (5 points)Brandy’s management plans to raise an additional $100 MM debt after acquisition of Macintoshgoes through. Why? Estimate the expected benefits from this move. v Q.1.6 (10 points)What kind of option was given to Macintosh’s shareholders by agreement that “everystockholder of Macintosh will have to exchange her Macintosh share on 1/02/04 for one shareof Brandy’s or to get $10 in cash”? Why was there a need to give this option? What was thevalue of this option on 1/02/03? Who pays for this option? ElaborateGiven: On 1/02/04 Macintosh will become part of Brandy’s. On that day Brandy’s shareswill trade at one of the two values only: $11 or $8.. vi

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