Question
Cloudy Skies Inc. is about to purchase Wet Sunday, Inc. Cloudy Skies anticipates that it will be able to expand Wet Sunday's customer base, and
Cloudy Skies Inc. is about to purchase Wet Sunday, Inc. Cloudy Skies anticipates that it will be able to expand Wet Sunday's customer base, and hence to increase Wet Sunday's earnings (before taxes) by $200,000 in the year after the takeover, and it expects to grow this income by 1.5% per year thereafter. You can assume that the corporate tax rate is 35%, that the risk-free interest rate is 2%, that the market risk premium is 5.5%, that Cloudy Skies has a beta of 1.25, and that Wet Sunday has a beta of 0.8. What is the maximum takeover premium that Cloudy Skies should be prepared to pay for Wet Sunday?
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