XYZ, Inc. is considering purchasing Widget, Inc. XYZ would finance the purchase using its current target mix of debt and equity: 60% debt, 40% equity. Widget currently has 8% coupon debt outstanding, which pays interest semiannually, matures in 25 years and is now priced at $833.13 per bond. Widget equity is not publicly traded, so its beta is not available. You are able to gather the following information however:                         Historical risk premium          6.5%                         Long run T-bonds                   6.0%             In addition, you found a portfolio of comparable firms to Widget. The beta of such portfolio is 1.6, and its debt/equity ratio is 1. In addition, XYZ'a marginal tax rate is 40%. The expected internal rate of return on Widget's cash flows is 12%. Should XYZ purchase Widget?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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XYZ, Inc. is considering purchasing Widget, Inc. XYZ would finance the purchase using its current target mix of debt and equity: 60% debt, 40% equity. Widget currently has 8% coupon debt outstanding, which pays interest semiannually, matures in 25 years and is now priced at $833.13 per bond. Widget equity is not publicly traded, so its beta is not available. You are able to gather the following information however:

                        Historical risk premium          6.5%

                        Long run T-bonds                   6.0%

            In addition, you found a portfolio of comparable firms to Widget. The beta of such portfolio is 1.6, and its debt/equity ratio is 1. In addition, XYZ'a marginal tax rate is 40%. The expected internal rate of return on Widget's cash flows is 12%. Should XYZ purchase Widget? 

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