Solaris Enterprises is evaluating the acquisition of the Lunaris Company, a small allequity electronic components supply company. Lunaris$$ earnings projects are shown below. Revenues are assumed to grow $20\%$ per year for the next three years, at which time they will remain constant for the foreseeable future. Operating costs are $40\%$ of revenues, while overhead expenses are $$100,000$ plus $10\%$ of revenues. The tax rate is $20\%.$ For a company in Lunaris$$ risk class, investors require a $25\%$ return.

Lunaris Company

$($dollars in thousands$)$

Year $1$

Year $2$

Year $3$

Year $4+$

Revenues

$$2,000\mathrm{.}00$

$$2,400\mathrm{.}00$

$$2,880\mathrm{.}00$

$$3,456\mathrm{.}00$

Operating costs

$$800\mathrm{.}00$

$$960\mathrm{.}00$

$$1,152\mathrm{.}00$

$$1,382\mathrm{.}40$

Overhead

$$300\mathrm{.}00$

$$340\mathrm{.}00$

$$388\mathrm{.}00$

$$445\mathrm{.}60$

Depreciation

$$250\mathrm{.}00$

$$250\mathrm{.}00$

$$250\mathrm{.}00$

$$250\mathrm{.}00$

Earnings before tax

$$650\mathrm{.}00$

$$850\mathrm{.}00$

$$1,090\mathrm{.}00$

$$1,378\mathrm{.}00$

Tax

$$130\mathrm{.}00$

$$170\mathrm{.}00$

$$218\mathrm{.}00$

$$275\mathrm{.}60$

Earnings after tax

$$520\mathrm{.}00$

$$680\mathrm{.}00$

$$872\mathrm{.}00$

$$1,102\mathrm{.}40$

Estimate the value of Lunaris under its current management.

The president of Solaris Enterprises believes that once they take over Lunaris he could reduce operating costs to $30\%$ of revenues from the currently assumed $40\%,$ and reduce overhead expenses to $$100,000$ plus $5\%$ of revenues from the currently assumed $$100,000$ plus $10\%$ of revenues. What is the value of Lunaris to Solaris if these changes are implemented?

An investment banker suggests that Solaris makes a cash offer of $$5,600,000$ to

Lunaris. The deal will be financed entirely with debt by borrowing $ $5,600,000$ at $12\%$ and paying down the debt in four equal installments. Thus, at the end of year four, the firm will be back to all equity. In the meantime, Solaris could take advantage of the tax benefits of debt financing. If Solaris follows the investment banker$$s suggestion, what is the NPV of the acquisition?