1) Calculate the Unlevered Beta for each comparable company using the formula for

Levered & Unlevered Beta with corporate taxes. Please note that the D/E ratio in
the formula is applied in practice with Book Value of Debt and Market Value of
Equity. Based on the three Unlevered Beta values, estimate the Unlevered Beta for
Landmark and Broadway, and their Levered Beta. Use this Levered Beta estimate
to calculate the WACC for Landmark and Broadway. Although the two companies
need not have the same WACC, for the purpose of this exercise, you can assume
that the WACC is the same.
The WACC of the Broadway Pre-merger and Post- Merger (For two scenarios: 100% debt
financing and 50% debt and 50% equity) is calculated using the following steps.
 Using data from Exhibit 2, Pre-Merger D/E ratio of Broadway is calculated using Debt
and equity values for the year 2013. Post- Merger D/E ratio is calculated for 100% debt
financing and 1:1 financing.
 Using information from exhibit 4, D/E ratio of all the comparable companies is
calculated and Unlevered beta is calculated using below formula

Levered beta= Unlevered beta*[1+(1-Tax)*D/E]

Unlevered beta = Levered beta / [1 + D/E * (1-Tax)]
Average of the unlevered beta of these 3companies gives Average unlevered beta
which is 1.1

 Using information given in exhibit 4 of the case, unlevered beta of comparable has
been computed and average of the same taken to compute industry average at 1.1
times.

 D/E ratio of Broadway (combined operations) is calculated for both scenarios. In case
of 1st scenario, D/E is 3.05 times and in case of 2 nd scenario, D/E is 0.60 times. Tax Rate
of 35% is taken to calculate levered beta for both the cases.
 From exhibit 5, risk- free rate (10-Yr Treasury Rate) - 2.56% and market risk premium –
5.9% are used to derive cost of equity and cost of debt.

Ke = Rf+beta(Rm-Rf)
Kat = (1-T)* Kbt
Kat- after tax cost
Kbt- before tax cost

 Cost of equity comes down from 22.15% to 11.71% in these scenarios. This helps us
understand how exposure to external debt raises risk and hence increases cost of
equity.

 Cost of debt post tax was 3.58% in case of 1st scenario and 3.25% in case of 2nd
scenario. WACC is derived at 8.17% and 8.53% respectively.
  Pre-Merger Post Merger
       

New @ 100%
Broadway Existing(2013) New @ 1:1 financing
debt financing

Long term debt 8.3 120 60

Equity 39.4 39.4 99.4
Total Capital 47.7 159.4 159.4
Debt % 17.40% 75.28% 37.64%
Equity % 82.60% 24.72% 62.36%
D/E 0.21 3.05 0.604
       
       
2nd
  1st Alternative (100% Alternative
Debt) (50% Debt) Pre Merger
Broadway D/E 3.05 0.60 0.21
Unlevered Beta 1.11 1.11 1.11
Tax Rate 35% 35% 35%
     
Levered Beta 3.32 1.55 1.27
     
Risk-free rate
2.56% 2.56% 2.56%
(Exhibit 5)
Market risk
5.90% 5.90% 5.90%
premium(Exhibit 5)
     
Cost of Equity
22.15% 11.71% 10.03%
(CAPM)
     
Cost of Debt (Pre-
5.50% 5.00%
tax) 5.00%
Cost of Debt (Post-
3.58% 3.25% 3.25%
tax)
     
Debt portion 75.28% 37.64% 17.40%
Equity portion 24.72% 62.36% 82.60%
     
WACC 8.17% 8.53% 8.85%
 Comparable Company 1 Comparable Company 2 Comparable Company 3

Equity beta (Exhibit 4) 1.69 1.25 1.56

Market capitalization $6,186.9 $3,151.7 $500.1
Debt $5,887.0 $355.0 $289.0
D/E 1.0 0.1 0.6

Beta(unlevered) 1.0 1.2 1.1

Average Beta(unlevered) 1.11 Levered beta= Unlevered beta*[1+(1-T)*D/T]

2. Calculate the Pre-Merger total firm value for each company, using DCF. Explain your
calculation of the Terminal Value and your assumptions in calculating the FCF.

The Pre-merger total firm value for each firm is calculated using the discounted flow method.
We have followed the following steps to calculate the firm value for each company:

 The future cash flows without the merger are already provided in the Exhibit 3 for both
the firms.
 We have taken the WACC calculated in the question 1 for the pre-merger case to be the
WACC used in calculating the discount factor (1/(1+WACC) ^time-period).
 The present value for each cash flow is then calculated using the formulae: PV = Future
cash flow * Discount factor.
 Terminal growth rate is provided for Landmark as 4% and same is taken for Broadway.
 Terminal Value is calculated using perpetuity formulae assuming 4 % growth rate as TV =
Cashflow/(R-g) where in our case R would the WACC and g would be the growth rate.
 The present value of the terminal value is calculated using the time-period of 6 years.
 The sum of the present value of the terminal value and present value of the future cash
flows for the first 5 years becomes the total value of the firm.

Landmark          
Year 2015 2016 2017 2018 2019
  1 2 3 4 5
Total FCF 0.7 1.0 1.2 1.4 1.6
WACC 8.85% 8.85% 8.85% 8.85% 8.85%
Discount factor 0.92 0.84 0.78 0.71 0.65
PV of cash flows 0.61 0.81 0.92 1.01 1.07
Sum of PV's 4.42        
           
Terminal Growth 4%        
Terminal Year
CashFlow 1.11        
Using perpuity formulae = C/(r-
Terminal Value 22.95   g)    
PV of terminal Value 13.79        
           
Company Value 18.22        
Non Current Liabilities 17.9        
Equity Value 0.32        
           

Broadway          
Year 2015 2016 2017 2018 2019
  1 2 3 4 5
Total FCF 2.84 3.12 3.31 3.50 3.70
WACC 8.85% 8.85% 8.85% 8.85% 8.85%
Discount Factor 0.92 0.84 0.78 0.71 0.65
PV of cash Flows 2.61 2.63 2.57 2.50 2.42
SUM of PV's 12.73        
           
Terminal Growth 4%        
Terminal Year Cash
Flow 2.51        
Using perpuity formulae = C/(r-
terminal Value 51.84   g)    
PV of Terminal Value 31.16        
           
Company Value 43.89        
Less Non current
liabilities 18.8        
           
Equity Value 25.09