Assume no taxes. Storm Inc. has 250,000 shares outstanding, P=$20, no debt. Current WACC is 15%. As

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Assume no taxes. Storm Inc. has 250,000 shares outstanding, P=$20, no debt. Current WACC is 15%. As of now, management expects that EBIT will be $750,000 per year forever. It now plans to buy another firm ABC Inc. (in the same industry, so assume similar risk) at a cost of $300,000. ABC will add $120,000 per year in perpetuity.

a) Suppose that Storm issues equity to buy the other firm. What will happen to Storm’s firm value when the merger is announced? Equity value? Share price?

b) How many shares will Storm have to issue to fund this purchase?

c) What is the return to Storm’s equityholders or cost of unlevered equity? Confirm your answer using the PV of all cash flows to shareholders at unlevered equity cost.

Repeat the analysis assuming that Storm issues debt (cost of 10%) to buy the other firm.

a) What will happen to Storm’s firm value when the merger is announced? Equity value? Debt value? Share price?

b) How much debt will it issue to fund the purchase?

c) What is the cost of levered equity? Confirm your answer by both computing the PV of all cash flows to shareholders at levered equity cost and using MMII.