Smart Acquires Snazzy
Smart Products plans to acquire Snazzy Snaps,which will create $8 million in incremental cash flows for Smart each year for the first six years.Smart Products plans to divest Snazzy Snaps at the end of the sixth year for $112,500,000.Smart's beta (b)is 1.2,and is expected to remain so after the acquisition.The risk free rate is 5 percent and the expected return on the market is 16 percent.Smart Products has a 100 percent equity capital structure which will be maintained post-acquisition.
-What is the maximum price Smart Products can pay for Snazzy Snaps?

Question

Quizplus · Accepted Answer

To find the maximum price Smart can pay for Snazzy Snaps, we need to calculate the present value of the incremental cash flows for the first six years and the present value of the divestiture price in year six.
First, we calculate the present value of the incremental cash flows using the formula: 
PV = CF / (1 + r)^n
where PV is the present value, CF is the cash flow each year, r is the discount rate, and n is the number of years.
PV of incremental cash flows = $8,000,000 / (1 + 0.16)^1 + $8,000,000 / (1 + 0.16)^2 + ... + $8,000,000 / (1 + 0.16)^6
PV of incremental cash flows = $32,386,800
Next, we calculate the present value of the divestiture price using the same formula:
PV of divestiture price = $112,500,000 / (1 + 0.16)^6
PV of divestiture price = $48,257,950
Finally, we add the two present values together to get the maximum price Smart can pay for Snazzy Snaps:
Maximum price = PV of incremental cash flows + PV of divestiture price
Maximum price = $32,386,800 + $48,257,950
Maximum price = $80,644,750
Therefore, the best choice is B.

Smart Acquires Snazzy Smart Products Plans to Acquire Snazzy Snaps,which Will Create $8