Question
Friendly's Inc is considering the acquisition of another firm in its industry. The acquisition is expected to increase Friendy's free cash flow by $6 million
Friendly's Inc is considering the acquisition of another firm in its industry. The acquisition is expected to increase Friendy's free cash flow by $6 million the first year and this contribution is expected to grow at a rate of 5% per year from then on. Friendly has egotiated a purchase price of $130 million. Current debt- equity ratio of 1/3. Friendly's cost of equity is 10% and the cost of debt is 8%. Tax rate is 40%.
1. If the acquisition has similar risk to the rest of Friendly Inc, what is the value of the deal?
2. How much debt must Friendly use to finance the acquisition and still maintain its debt-to-value ratio?
3. How much of the acquisition cost must be financed with equity?
4. Compute the value of acquisition using the APV method, assuming Friendly will maintain a constant debt-equity ratio for the acquisition.
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