30.13 Company A is contemplating acquiring company B. Company Bs projected revenues, cost, and required investment appear

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30.13 Company A is contemplating acquiring company B. Company B’s projected revenues, cost, and required investment appear in the table that follows. The table also shows sources for financing company B’s investments if B is acquired by A. The table incorporates the following information:

Company B will immediately increase its leverage with a $110 million loan, which would be followed by a $150 million dividend to company A. (This operation will increase the debt-to-equity ratio of company B from 1/3 to 1/1.)

Company A will use $50 million of tax-loss carryforwards available from the firm’s other operations.

The terminal, total value of company B is estimated to be $900 million in five years, and the projected level of debt then is $300 million.

The risk-free rate and the expected rate of return on the market portfolio are 6 percent and 14 percent, respectively. Company A analysts estimate the weighted average cost of capital for their company to be 10 percent. The borrowing rate for both companies is 8 percent. The beta coefficient for the stock of company B (at its current capital structure) is estimated to be 1.25.

The board of directors of company A is presented with an offer for $68.75 per share of company B, or a total of $550 million for the 8 million shares outstanding.
Evaluate this proposal. The table produced below may help you.

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Corporate Finance

ISBN: 9780071229036

6th International Edition

Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe

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