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Pomegranate-Cellular Inc. (PC), a company producing mobile phones, would like to expand its business. It is currently looking into acquiring Albatross, which also produces mobile phones and is one of its closest competitors. Albatross has a book value of debt of $125 million selling at 80% of par value, book equity of $90 million, 180 million shares selling at $3.50 per share, and $260 million in cash. PC will need to issue new debt and equity to finance the acquisition and PC estimates that the issuance costs of new debt and equity will be $10 million. Since PC will still maintain the same debt to equity ratio as before and since PC and Albatross have the same beta, its weighted average cost of capital (WACC) will remain at 13%. If the acquisition goes through this year, it will generate a free cash flow of $26 million next year, i.e., in its first year of operation. This cash flow is expected to grow at an annual rate of 15% for 5 years and then to grow at a lower rate of 7% forever. What is the net present value of this acquisition project for PC? (Hint: Start by calculating the acquisition cost in year 0 of the project.) Draw the timelines.

Answer:

a. $414.370 million

b. $79.344 million

c. $134.765 million

d. $60.634 million

e. $270.506 million