QUESTION $5$:

ABC Limited an all equity financed firm expects EBIT of $$2,000,000$ for the next two years and

after that decline at $2\%$ per year forever. ABC management would like to leverage the firm to

increase its value. ABC has $40\%$ corporate tax rate and the required rate of return is $10\%$ABC

has estimated the following probability distribution of bankruptcy at various debt levels.

Present value of bankruptcy related costs $=$$$10,000,000$

In the meantime XYZ Corporation which is also in $40\%$ tax bracket is considering acquiring

ABC. XYZ believes that after the acquisition ABC's EBIT will remain at $$2,000,000$ per year

for the first two years and after that will start increasing at $3\%$ per year forever. XYZ will

finance ABC acquisition with both debt and equity. Whatever price XYZ will offer, $$10,000,000$

of that will be financed through perpetual debt. XYZ expects no risk of bankruptcy, if it doesn't

borrow more than $$15,000,000$ 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$+10\%$ premium. If

XYZ pays $$10,000,000$ cash and remaining in stock then how many shares should be issued

to ABC shareholders?