ssume now a firm that is an existing customer of Financeur Co. is considering a buyout of Financeur Co. to allow them to integrate production activities. The potential acquiring firm’s management has approached an investment bank for advice. The bank believes that the firm can gear Financeur Co. to a higher level, given that its existing management has been highly conservative in its use of debt. It also notes that the customer’s firm has the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations. a) What would the required rate of return for Financeur Co.’s equity become if the proposed gearing structure were adopted following acquisition by the customer?
You have the following initial information on Financeur Co. on which to base your calculations and discussion for question 2):
• Current long-term and target debt-equity ratio (D:E) = 1:3
• Corporate tax rate (TC) = 30%
• Expected Inflation = 1.55%
• Equity beta (E) = 1.6325
• Debt beta (D) = 0.203
• Expected market premium (rM – rF) = 6.00%
• Risk-free rate (rF) =2.05%
2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyout of Financeur Co. to allow them to integrate production activities. The potential acquiring firm’s management has approached an investment bank for advice. The bank believes that the firm can gear Financeur Co. to a higher level, given that its existing management has been highly conservative in its use of debt. It also notes that the customer’s firm has the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations.
a) What would the required
Step by step
Solved in 3 steps
