Firm A plans to acquire Firm B. The acquisition would result in incremental cash flows for Firm A of £10 million in each of the first five years. Firm A expects to divest Firm B at the end of the fifth year for £100 million. The β for Firm A is 1.1, which is expected to remain unchanged after the acquisition. The risk-free rate, Rf, is 7 per cent, and the expected market rate of return, Rm, is 15 per cent. Firm A is financed by 80 per cent equity and 20 per cent debt, and this leverage will also remain unchanged after the acquisition. Firm A pays interest of 10 per cent on its debt, which will also remain unchanged after the acquisition. Required: a) Disregarding taxes, what is the maximum price that Firm A should pay for Firm B? b) Firm A has a share price of £30 per share and 10 million shares outstanding. If Firm B’s shareholders are to be paid the maximum price determined in part (a) via a new share issue: i. how many new shares will be issued ii. what will be the post-merger share price? c) Alternatively, Firm A is considering investing in a state-of-the-art artificial intelligence solution. This solution will cost £300,00. The annual cash flows are expected to be: Year Cash flow (£) 1 100,000 2 110,000 3 124,000 The company’s money cost of capital is 9% and inflation is expected to be 5% during the life of the project. Required: Calculate the NPV of the project using the money cost of capital as the discount rate.
Question 3
Firm A plans to acquire Firm B. The acquisition would result in incremental cash flows
for Firm A of £10 million in each of the first five years. Firm A expects to divest Firm B
at the end of the fifth year for £100 million. The β for Firm A is 1.1, which is expected
to remain unchanged after the acquisition. The risk-free rate, Rf, is 7 per cent, and
the expected market
cent equity and 20 per cent debt, and this leverage will also remain unchanged after
the acquisition. Firm A pays interest of 10 per cent on its debt, which will also
remain unchanged after the acquisition.
Required:
a) Disregarding taxes, what is the maximum price that Firm A should pay for Firm B?
b) Firm A has a share price of £30 per share and 10 million shares outstanding. If
Firm B’s shareholders are to be paid the maximum price determined in part (a) via
a new share issue:
i. how many new shares will be issued
ii. what will be the post-merger share price?
c) Alternatively, Firm A is considering investing in a state-of-the-art artificial
intelligence solution. This solution will cost £300,00. The annual cash flows are
expected to be:
Year Cash flow (£)
1 100,000
2 110,000
3 124,000
The company’s money cost of capital is 9% and inflation is expected to be 5%
during the life of the project.
Required:
Calculate the
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