Question 3 (20 marks)

Your company has two divisions. One division sells software and the other division sells computers. You have decided that Dell Computer is very similar to your computer division in terms of both risk and financing. You find the following information:

• 10,000 individual bonds with a face value of $1,000 that will mature in 10 years time and offer a coupon that is paid half-yearly. The coupon rate for these bonds is 10% per annum. The current market interest rate for these bonds is 8% per annum.
• 700,000 ordinary shares, which are expected to pay a $1 dividend per share next year. Dividends are expected to grow at 4% per annum perpetually. The current share price is $20.
• 300,000 preference shares, which pay an annual dividend of 0.5% on a stated value of $100. Each preference share is trading at a market price of $8.
• The company tax rate is 30%.

Required:

a) Compute the WACC. (14 marks)

b) Your company is considering an acquisition of Sun Ltd whose WACC is 10%. Your companys purchase of Sun Ltd will cost 100 million, and will generate cash flows that start at $9 million in Year 1 and then grow at 3% per year forever. The cost of environmental clean-up is expected to be $300,000 per year starting from Year 5 in perpetuity. What is the NPV of the acquisition? Should your company go ahead with the acquisition and why? (6 marks)