Reference no: EM13202411

Jupiter Incorporated is interested in acquiring Mercury Limited, a privately held firm whose owner desires to retire. Mercury Limited is 100% owned by the current owner. It has revenues of $18 million and an EBIT of $7.5 million in the year just ended. The book value of the firm's debt is $6 million, while the book value of its equity is $10 million. For publicly traded firms in the same industry, the average debt-equity ratio is 0.40 (based on the book value of debt and equity), and the marginal tax rate is 35%. The average beta of publicly traded firms that are in the same business is 1.5. Capital expenditures and depreciation amounted to $1.2 million and $0.8 million in the year just ended. Both items are expected to grow at the same rate as revenues for the next 5 years. Capital expenditures and depreciation are expected to be equal beyond five years (i.e., capital spending will be internally funded).

As a result of excellent working capital management practices, the change in working capital is expected to be essentially zero throughout the forecast period and beyond. Revenue and operating income are expected to grow at an annual rate of 25% for the next 5 years and 4% per year thereafter.

The 10-year Treasury bond rate is 4%, and the historical excess return (over the Treasury bond rate) on a broad index of stocks is 4.5%. The pre-tax cost of debt for similar nonrated firms is 8%.

Estimate the value of Mercury Limited's equity. Formula hint: the equation that relates levered and unlevered betas is: BL=BU * (1+ ( 1-T) * D/E where ßL is the levered beta, ßU is the unlevered beta, T is the corporate tax rate, and D/E is the debt-equity ratio.