Problem 6 (15 points) ABC Industries is considering the acquisition of another f
ID: 2657850 • Letter: P
Question
Problem 6 (15 points) ABC Industries is considering the acquisition of another firm in its industry for $100 million. The acquisition is expected to increase ABC's free cash flow by $5 million the first year and this contribution is expected to grow at a rate of 3% every year thereafter. ABC currently maintains a debt to equity ratio of 1 /2, its marginal tax rate is 40%, its cost of debt is 6%, and its equity cost of capital is 10%. ABC Industries wl maintain a constant debt-equity ratio for the acquisition. Use the WACC, the APV and the FTE method to find the value of this acquisition.Explanation / Answer
ii) Adjusted Present Value Method (APV)
Value of Acquisition i) WACC method rWACC= D/V*rD&(1-T)+ E/V*rE Given: a. Debt : Equity 01:02 b. Cost of Debt 6% c. Cost of Equity 10% d. Tax Rate 40% e. Cash Flows (EBIT) - $ Million 5% f. Growth Rate 3% rWACC= 1/3*6%*(1-40%)+2/3*10% => 0.078666667 r wacc = 7.87% Value of Firm = Cash Flows/ (rWACC - Growth rate) => 5/(7.8667%-3%) => 5/(4.8667%) => 1.02739726 =>