A. the appropriate discount rate ABC should use to discount the equity cash flows from XYZ is cost of equity of XYZ. cost of equity of XYZ = risk-free rate + XYZ's beta* (market return - risk-free rate) = 4.5% + 1.36* (10.55% - 4.5%) = 4.5% + 1.36*6.05% = 4.5% + 8.228% = 12.728% B. Present value of XYZ cash inflows = Year 1 net cash flow/(1+cost of equity) + Year 2 net cash flow/(1+cost of equity)2 + Year 3 net cash flow/(1+cost of equity)3 + terminal value/(1+cost of equity)3 Present value of XYZ cash inflows = $3/(1+0.12728) + $3/(1+0.12728)2 + $3/(1+0.12728)3 + $15/(1+0.12728)3 terminal value in year 4 is at the end of year 3. so it will be discounted for 3 years only. Present value of XYZ cash inflows = $3/1.12728 + $3/1.127282 + $3/1.127283 + $15/1.127283 Present value of XYZ cash inflows = $3/1.12728 + $3/1.2707601984 + $3/1.432502556452352 + $15/1.432502556452352 Present value of XYZ cash inflows = $2.6612731530764317649563551202895 + $2.3607915984284576724117833371386 + $2.0942371003020169544494565122583 + $10.471185501510084772247282561292 = $17.587 million the present value (to the nearest thousand) of the XYZ cash inflows to ABC is $17.587 million. C. acquisition price of XYZ = $15 million *145% = $21.75 million ABC should not proceed with the acquisition because the acquisition price of XYZ of $21.75 million is higher than the present value of the XYZ cash inflows to ABC of $17.587 million