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You have been given the job of evaluating the following merger candidate. You ha

ID: 2625619 • Letter: Y

Question

You have been given the job of evaluating the following merger candidate. You have collected the following cash flow for the acquisition candidate for the proposed merger (in millions):

Year                                                   1                  2                       3                            4                            5__

Cash flows now                                    80            85                       105                         145                         180

Additional cash flows with merger      40               90                        100                         125                         150

Total cash flows with merger          120            175                         205                         270                         330

Risk free rate of return                                                                                                       3.5%

Beta for this project (the company after merging)                                                             1.6         

Market risk premium                                                                                                         5%         

Pre-tax cost of debt                                                                                                             7.5%

Marginal tax rate                                                                                                               30%

Number of shares outstanding for the target company (millions)                                      55          

Current market price per share for the target company                                                 $60        

Percentage of the acquisition financed with debt                                                           50%

Percentage of the acquisition financed with common equity                                          50%      

What is the after tax cost of debt?

What is the after tax cost of common equity

What is the weighted average cost of capital for this acquisition candidate?

What is the maximum price per share you are willing to pay for this candidate?

Based on the numbers above, would you pursue this candidate?

Explanation / Answer

calculate the present value of the cash flow using cost of equity

use financial calculator

P = 120/( 1+ 0.115)^1 + 175 /( 1+ 0.115)^2 + ...........330/( 1+ 0.115)^5

P = 762.44

yes i will purchase it because its present valure is positive

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