QUESTION 2

(a) A Ltd. is analyzing the possible acquisition of B Ltd.. Both firms have no debt. A believes the acquisition will increase its total after-tax annual cash flows by K2.8 million indefinitely. The current market value B is K78 million, and that of A is K135 million. The appropriate discount rate for the incremental cash flows is 10 percent. A is trying to decide whether it should offer 40 percent of its stock or K94 million in cash to Bs shareholders.

(i) What is the cost of each alternative?

(ii) What is the NPV of each alternative

(iii) Which alternative should A choose? (5 marks each)