Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

4.) Southwestern Industries and Cactus Airlines Southwestern Industries, a diversified industrial corporation, is considering an acquisition of Cactus Airlines, a small passenger air carrier that

4.) Southwestern Industries and Cactus Airlines

Southwestern Industries, a diversified industrial corporation, is considering an acquisition of

Cactus Airlines, a small passenger air carrier that operates in the southwestern United States.

After the acquisition, Southwestern plans to have a target debt-to-equity (D/E) ratio of 0.15.

Cactus Airlines is quite similar in its size and operations to another company, Arizona Air.

You are given the following information:

Risk-free rate = 4.3%

Market risk premium = 8.4%

Corporate tax rate = 35%

Southwestern Industries: E = 1, D = 0, rD = 5.0%

Cactus Airlines: E = 1.5, D = 0.3, (D/E) = 0.25

Arizona Air: E = 1.5, D = 0.2, (D/E) = 0.25

A study of historical data reveals that Cactus Airlines maintains an essentially fixed amount of

debt on its balance sheet, while Arizona Air does not. However, Arizona Air frequently

rebalances its capital structure in response to the performance of its stock, and therefore

maintains a relatively stable D/E ratio.

a.) What are the unlevered asset betas of Cactus Airlines and Arizona Air?

b.) Compute the WACC that Southwestern should use to discount the cash flows from the

acquisition.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Real Estate Finance And Investment

Authors: Terrence M. Clauretie, G. Stacy Sirmans

8th Edition

1629809942, 9781629809946

More Books

Students also viewed these Finance questions

Question

CL I P COL Astro- L(1-cas0) Lsing *A=2 L sin(0/2)

Answered: 1 week ago

Question

What are all the ways you count or measure customer complaints?

Answered: 1 week ago

Question

Do your staff and customers know these examples?

Answered: 1 week ago