(ST–1)

Valuation Red Valley Breweries is considering an acquisition of Flagg Markets. Flagg currently has a cost of equity of 10%; 25% of its financing is in the form of 6% debt, and the rest is in common equity. Its federal-plus-state tax rate is 40%. After the acquisition, Red Valley expects Flagg to have the following FCFs and interest payments for the next 3 years (in millions):

Year 1 Year 2 Year 3 FCF $10.00 $20.00 $25.00 Interest expense 28.00 24.00 20.28 Chapter 21: Mergers, LBOs, Divestitures, and Holding Companies 863 After this, the free cash flows are expected to grow at a constant rate of 5%, and the capital structure will stabilize at 35% debt with an interest rate of 7%.