Plumbing Co. is evaluating a proposal to acquire Bathroom Goodies for $75,000 in cash. Bathroom Goodies has total liabilities of $90,000 and has some particular assets that Plumbing Co. needs. Plumbing Co. will sell the assets it does not need for $62,500 after the acquisition. It is estimated that Plumbing Co.’s cash flows will increase $25,000 per year over the next 10 years as a result of the assets obtained from Bathroom Goodies. Plumbing Co. has a cost of capital of 12.5%.
a. Calculate the effective cost (or net cost) of the assets obtained from Bathroom Goodies.
b. If the acquisition is the only way Plumbing Co. can obtain the particular assets, should Plumbing Co. proceed with the acquisition? Explain.
c. After more enquiries, Plumbing Co. discovered it could purchase the same particular assets. The new assets cost $110,000 and would result in a $30,000 annual cash inflow for 10 years. To obtain the assets it needs, should Plumbing Co. acquire Bathroom Goodies or purchase the new assets? Explain your answer.