ABC Corporation is considering an acquisition of XYZ. XYZ has a capital structure of 40% debt and
Question:
ABC Corporation is considering an acquisition of XYZ. XYZ has a capital structure of 40% debt and 60% equity, with a current book value of $20 million in assets. XYZ’s pre-merger beta is 1.46 and is not likely to be altered as a result of the proposed merger. ABC’s pre-merger beta is 1.12, and both it and XYZ face a 35% tax rate. ABC’s capital structure is 50% debt and 50% equity, and it has $24 million in total assets. The net cash flows from XYZ available to ABC’s stockholders are estimated at $5.0 million for each of the next four years and a terminal value of $19.0 million in Year 4.
Additionally, new debt issued by the combined firm would yield 10% after-tax, and the cost of equity is estimated at 14.59%. Currently, the risk-free rate is 5.0% and the expected market risk return is 15.50%.
- What is the merged firm’s WACC?
- What is the merged firm’s new beta?
- What is the appropriate discount rate ABC should use to discount the equity cash flows from XYZ?
- What is the present value (to the nearest thousand) of the XYZ cash inflows to ABC?
- If the acquisition price of XYZ is 145% of XYZ’s current book value of assets, should ABC proceed with the acquisition?
Introduction to Corporate Finance What Companies Do
ISBN: 978-1111222284
3rd edition
Authors: John Graham, Scott Smart