The executives of Babur Chemicals are evaluating a potential acquisition candidate: Arathi Chemicals. The forecast of free cash flow under the current management is as follows:

Cash flows are expected to grow at 6.5 percent after year 6.
The executives of Babur believe that NOPAT margin can be improved by 8 percent and working capital investment can be cut by 20 percent. Arathi Chemicals has a strong marketing network which could be used to sell Babur’s existing products. The arrangement is likely to generate savings of Rs 10 lac per annum for 8 years.
(in percent)
for Babur for Arathi Cost of equity 20 22 Tax rate 35 35 Cost of debt 12.5 13.5 Target D/V 30 20

a. Estimate the value of Arathi under the current management.

b. Estimate the value of Arathi for Babur.

c. Can Babur’s cost of capital be used to discount cash flows of Arathi? If yes, when? If not, why not?

d. Babur intends to increase debt by Rs 25 lac. What is the value of interest tax shields to Babur? Assume that debt is permanent.

e. Conduct a sensitivity analysis.