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Assume ABC corporation is considering the acquisition of another firm in its industry. The acquisition is expected to increase ABCs free cash flow by 5
Assume ABC corporation is considering the acquisition of another firm in its industry. The acquisition is expected to increase ABCs free cash flow by 5 million the first year, and this contribution is expected to grow at a rate of 4% per year from then on. ABC has negotiated a purchase price of 110 million. Assume also ABCs weighted average cost of capital is 7.5%. After the transaction, ABC will adjust its capital structure to maintain its current debt-equity ratio of 2.
- (i) If the acquisition has a similar risk to the rest of the ABC, what is the value of this deal?
- (ii) Assume now that ABC proceeds with the acquisition. How much debt must the company use to finance the acquisition and still maintain its debt-to-value ratio? How much of the acquisition cost must be financed with equity?
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