(1) on LL’s existing debt, which is $55 million at a rate of 9%, and (2) on new debt expected to be issued over time to help finance expansion within the new “L division,” the code name given to the target firm. If acquired, LL will face a 40% tax rate.

Security analysts estimate LL’s beta to be 1.3. The acquisition would not change Lyons’s capital structure, which is 20% debt. Zona realizes that Lyons Lighting’s business plan also requires certain levels of operating capital and that the annual investment could be significant.

The required levels of total net operating capital are listed in the table.

Zona estimates the risk-free rate to be 7% and the market risk premium to be 4%. He also estimates that free cash flows after 2015 will grow at a constant rate of 6%. Following are projections for sales and other items.

Hager’s management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Hager’s board.