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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.

  1. (i) If the acquisition has a similar risk to the rest of the ABC, what is the value of this deal?
  2. (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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