Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Laker is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Laker will need $10 million of net new investment in operating capital. Laker's marginal tax rate is 40%. After the second year, the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 4%. Blazer has determined that Laker's cost of equity is 17.5% , and Laker currently has no debt outstanding. Assume that all cash flows occur at the end of the year, Blazer must pay $45 million to acquire Laker. What it the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.

Question

Quizplus · Accepted Answer

The NPV is calculated by determining the present value of Laker's future cash flows and tax shields, discounted at the cost of equity, and then subtracting the acquisition cost. The calculation involves finding the free cash flows for the first two years, accounting for tax shields, and then using the perpetuity growth formula for the cash flows beyond year two. The present value of these cash flows is then compared to the acquisition cost to find the NPV.