V2 - A5 6-10 Please show workings with solutions - I posted this question previously on Chegg but the persons answers did not take into account tax. This assignment is based around tax - so please read the questions carefully and account for tax when applicable!

Questions 6-10 relate to the same mega problem

For purposes of the questions that follow, assume that changes in working capital are negligible and capex and depreciation are of the same magnitude and therefore cancel each other.

Your company is considering acquiring XYZ, Inc., a biotechnology firm. XYZ, Inc. has expected annual EBIT of $1,500,000 in perpetuity, and the appropriate discount rate for the risk associated with the cash flow is 15%. XYZ is an all equity firm and has 500,000 shares outstanding. Suppose the corporate tax rate is 35%.

Q6. What is the amount that your company should offer to acquire (or purchase) XYZ, Inc?

Q7. What is the current price-earnings (or P/EPS) ratio of XYZ, Inc?

Your company is considering acquiring XYZ, Inc., a biotechnology firm. XYZ, Inc. has expected annual EBIT of $1,500,000 in perpetuity, and the appropriate discount rate for the risk associated with the cash flow is 15%. XYZ is an all equity firm and has 500,000 shares outstanding. The CEO of XYZ, Inc. has a very exciting plan to make her company look more attractive to your company. She suggests to her CFO that if the firm issues $5M debt in perpetuity with a return of 10%, and uses this debt to repurchase some of the shares of the company, it will make the firm more attractive to acquirers. The CFO is sceptical of the CEOs plan and argues with her about the logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally simply states: I do not have to convince you, John, especially since my plan is fool proof. My debt-based strategy will make our company attractive to any acquirer because it will lower our price-earnings ratio and, consequently, make them offer us a lot more money for our assets than they would otherwise. Assume the corporate tax rate is 35% but the interest payments on debt are not tax deductible.

Q8. Is the CEO correct in believing that the price-earnings ratio of XYZ, Inc will drop?

Yes

No

Mabye

Q9. What will be the new P/E ratio of XYZ, Inc if it adopts this new debt-enhanced strategy?

Q10. Is the CEO correct in concluding that your company will pay more to acquire XYZ, Inc?

Mabye

No

Yes