Gamma Technologies has a normalized pretax income of $60 million, a 28% tax rate, and a Total Debt/Total Capital ratio of 25%. The company plans to undertake a major acquisition financed by new debt that will increase its Total Debt/Total Capital ratio to 45% (8 percentage points above its industry average). As a result, Gamma's credit rating is expected to be downgraded, raising its Weighted Average Cost of Capital from 9% to 11%. a. What is the value of Gamma Technologies prior to the credit rating downgrade? b. Assuming the acquisition will lead to a 25% increase in normalized pretax income, what is Gamma's value in the aftermath of the credit downgrade?
Gamma Technologies has a normalized pretax income of $60 million, a 28% tax rate, and a Total Debt/Total Capital ratio of 25%. The company plans to undertake a major acquisition financed by new debt that will increase its Total Debt/Total Capital ratio to 45% (8 percentage points above its industry average). As a result, Gamma's credit rating is expected to be downgraded, raising its Weighted Average Cost of Capital from 9% to 11%. a. What is the value of Gamma Technologies prior to the credit rating downgrade? b. Assuming the acquisition will lead to a 25% increase in normalized pretax income, what is Gamma's value in the aftermath of the credit downgrade?
Chapter3: Evaluation Of Financial Performance
Section: Chapter Questions
Problem 7P
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What is the a and b ? General accounting question

Transcribed Image Text:Gamma Technologies has a normalized pretax income of $60 million, a 28% tax
rate, and a Total Debt/Total Capital ratio of 25%. The company plans to undertake
a major acquisition financed by new debt that will increase its Total Debt/Total
Capital ratio to 45% (8 percentage points above its industry average). As a result,
Gamma's credit rating is expected to be downgraded, raising its Weighted Average
Cost of Capital from 9% to 11%.
a. What is the value of Gamma Technologies prior to the credit rating downgrade?
b. Assuming the acquisition will lead to a 25% increase in normalized pretax income,
what is Gamma's value in the aftermath of the credit downgrade?
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