Texas Steel Corporation is considering the acquisition of Everton Limited. Both Texas Steel Corporation and Everton Ltd are entirely equity financed. The management of Texas Steel Corporation has estimated that if it takes over Everton Ltd it can increase the pre tax cash flows of Everton Ltd by $1 million every year.

The current market value of Texas Steel Corporation is $40 million and it has 4 million shares in issue. The current market value of Everton Limited is $25 million and it has 3 million shares in issue.

Everton Limited has an equity beta of 0.5. The return on the market portfolio is 12% and the return on government treasury bills is 4%. Everton Limited pays tax at the rate of 25% on its profits.

If the transaction goes ahead Texas Steel Corporation will incur acquisition costs of $750,000.

Required:

1. 1. Calculate the cost of equity capital for Everton Limited.

2. Calculate the increase in the value of Everton Limited that Texas Steel Corporation expects to achieve.

Answer rating: 100% (QA)

Step 1 Calculate the Cost of Equity Capital for Everton Limited The cost of equity can be calculated ... View the full answer