7) M&A. For this and the next 2 questions: Magiclean Corporation is considering

Question

7) M&A. For this and the next 2 questions: Magiclean Corporation is considering an acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) in 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02 and both it and Dustvac face a 40 percent tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next four years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. Additionally, new debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6% and the market risk premium is 4%. Dustvac's pre-merger WACC is 9.83%.

7) Under the APV approach, calculate unlevered cost of equity using the following formula: wdrd + wErEL.

A) 10.01%

C) 11.29%

D) 11.44%

E)   13.49%

12) CF Estimation. In which of the following situations would a firm's net cash flow from a capital project be affected?

A) A firm spent $5,000 in the previous year in a training program for a group of six engineers who will operate a highly computerized production machinery now being evaluated

C) A new high tech manufacturing equipment will replace an existing one. The annual insurance premium on the existing equipment is $1,000. The replacement equipment would also require an annual insurance cost of $1,000

D) None of the above cash flows would be considered an incremental net cash flow in capital budgeting

16) Which of the following statements is TRUE? [I] An increase in depreciation expenses would generally cause a firm's net income to rise [II] An increase in depreciation expenses would generally cause a firm's net cash flow to rise [III] If a single project has a normal cash flow pattern, the NPV, IRR and MIRR would give the same accept/reject decision [IV] When a project has non normal cash flows, there may be more than one IRR although the MIRR would usually produce a unique solution [V] If mutually exclusive projects have unequal lives, the IRR, and not the NPV, should be used to make capital budgeting decision

A) II, III, IV

C) I, III, IV

D) II, IV, V

E) IV and V

Explanation / Answer

Ans 7)The levered cost of equity is 6% + 1.36(4%) = 11.44%, the percent of debt is $5/($5 + $10) = 0.333. The rate on the debt is 11%. The unlevered cost of equity is w d r d + w s r sL = 0.333(11%) + 0.667(11.44%) = 11.29% .

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