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QUESTION 5 : ABC Limited an all equity financed firm expects EBIT of $ 2 , 0 0 0 , 0 0 0 for the
QUESTION :
ABC Limited an all equity financed firm expects EBIT of $ for the next two years and
after that decline at per year forever. ABC management would like to leverage the firm to
increase its value. ABC has corporate tax rate and the required rate of return is ABC
has estimated the following probability distribution of bankruptcy at various debt levels.
Present value of bankruptcy related costs $
In the meantime XYZ Corporation which is also in tax bracket is considering acquiring
ABC. XYZ believes that after the acquisition ABC's EBIT will remain at $ per year
for the first two years and after that will start increasing at per year forever. XYZ will
finance ABC acquisition with both debt and equity. Whatever price XYZ will offer, $
of that will be financed through perpetual debt. XYZ expects no risk of bankruptcy, if it doesn't
borrow more than $ to finance the acquisition.
The following information has been collected about XYZ Corporation:
a At what debt level value management of ABC can maximize the ABC value?
b What is the value of ABC to XYZ How much is the synergy?
c What is the minimum offer acceptable to ABC and what is the maximum XYZ would be
willing to offer.
d Suppose the price agreed upon is the minimum offer acceptable to ABC premium. If
XYZ pays $ cash and remaining in stock then how many shares should be issued
to ABC shareholders?
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