A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target company€™s equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the target€™s cash flows and sell it for 12 times free cash flow in year five. Projected free cash flows and selling price are as follows

To finance the purchase the investors have negotiated a $400 mil-lion, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition.

a. Estimate the target firm€™s asset beta.
b. Estimate the target€™s unlevered, or all-equity, cost of capital (K A ).
c. Estimate the target€™s all equity present value.
d. Estimate the present value of the interest-tax shields on the acquisition debt discounted at KA.
e. What is the highest price the investors can reasonably justify paying for the target company?
f. What does your estimated maximum acquisition price in question (e) Assume about the costs of financial distress?

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Year Free cash flows Selling price Total free cash flows fS millions) $25 $40 $45 $50 $50 $25 $40 $45 $50 $650 $600 Selected Additional Information Tax rate Risk-free interest rate Market risk premium 40 percent 3 percent 5 percent