Raymond Supply, a National Hardware Chain, Is Considering Purchasing a Smaller

Multiple Choice

Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP) . Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values: $\begin{array} { l c c c r } \text { Year } & 1 & 2 & 3 & 4 \\ \text { Free cash flow } & \$ 1 & \$ 3 & \$3 & \$ 7 \\\text { Unlevered harizan value } & & & & 75 \\\text { Tax sheld } & 1 & 1 & 2 & 3 \\\text { Harizon value of tar shield } & & & &32\end{array}$
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. Using the compressed adjusted present value approach, what is the value of SGP to Raymond?

A) $53.40 million
B) $61.96 million
C) $64.64 million
D) $76.96 million
E) $79.64 million