Eastern Steel Manufacturing is

  1. Eastern Steel Manufacturing is considering acquiring ChicagoIron Works. Eastern Steel   

expects Chicago Iron Works’ free cashflow in the first year following the closing date forthe  

acquisition will be $125 million andthat it will grow thereafter at the rate of 10% per year for

the next 5 years. Eastern Steel’s WACCfor the acquisition is 12%, and its investment banker

estimates that the perpetuity growthrate for calculating the terminal value is 2% per year.

  1. Specify Chicago Iron Works’ free cash flow stream for years 1through 6.
  2. Estimate the terminal value for the acquisition.
  3. Calculate the value of Chicago Iron Works.
  4. Eastern Steel believes it can acquire Chicago Iron Works for$1.6 billion.  Should Eastern Steel proceed with theacquisition? Justify your answer.


(All values in million)

a) Free cash Flow to Firm(FCFF1)=$125

FCFF2=FCFF1(1+g1) [where,g1=growth rate for 1st phase=10%]

Year FCFF($)
1 FCFF1=125(1+0.10)=137.5
2 FCFF2=137.5(1+0.10)=151.25
3 FCFF3=151.25(1+0.10)=166.38
4 FCFF4=166.38(1+0.10)=183.01
5 FCFF5=183.01(1+0.10)=201.31
6 FCFF6=201.31(1+0.10)=221.45

b) Terminal Value(V6):

V6= FCFF7/(K0-g2)[where g2=perpetuity growth rate=2%=FCFF6(1+g2)/(0.12-0.02) K0=Costof Capital=WACC=12%] =221.45(1+0.02)/0.10 =$ 2258.79

c) Value of Chicago Iron works(V):

  [Where, n=number of years] =

=$1597.69 million

d) Eastern Steel believes it can aquire ChicagoIron works at $1.6 billion.

Here we found the value of the firm as $1597.69million or 1.59billion which is almost near to 1.6 billion. Therefore EasternSteel should proceed with its acquisition.   


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