Needsalift, Inc.
You are analyzing the potential acquisition of Nothing Better! Ice Creams, Inc. by your firm, Needsalift, Inc. The ice cream firm is a wholly owned subsidiary of Grand Lake Investments, which has set a firm selling price of $10,000,000. From your work you estimate that Nothing Better! will generate the following incremental cash flows for Needsalift:

Year Incremental Cash Flow
1 $1,000,000
2 $1,500,000
3 $3,000,000
4 $4,000,000
5 $4,500,000

To fund the $10 million price, Needsalift can use $2 million from internal sources (retained earnings) with a required return of 15 percent, while the rest would come from a new debt issue yielding 10 percent. Needsalift’s tax rate is 40 percent

-What is the required return on the acquisition of Nothing Better! for Needsalift?

Question

Needsalift, Inc.
You are analyzing the potential acquisition of Nothing Better! Ice Creams, Inc. by your firm, Needsalift, Inc. The ice cream firm is a wholly owned subsidiary of Grand Lake Investments, which has set a firm selling price of $10,000,000. From your work you estimate that Nothing Better! will generate the following incremental cash flows for Needsalift:

Year	Incremental Cash Flow
1	$1,000,000
2	$1,500,000
3	$3,000,000
4	$4,000,000
5	$4,500,000

To fund the $10 million price, Needsalift can use $2 million from internal sources (retained earnings) with a required return of 15 percent, while the rest would come from a new debt issue yielding 10 percent. Needsalift’s tax rate is 40 percent

-What is the required return on the acquisition of Nothing Better! for Needsalift?

Quizplus · Accepted Answer

The required return on the acquisition is the weighted average cost of capital (WACC) of the financing used to fund the acquisition. The WACC is calculated as follows:WACC = (Weight of equity * Cost of equity) + (Weight of debt * Cost of debt) * (1 - Tax rate)The weight of equity is the proportion of the acquisition price that is funded from internal sources, while the weight of debt is the proportion of the acquisition price that is funded from debt. In this case, the weight of equity is $2 million / $10 million = 20%, and the weight of debt is $8 million / $10 million = 80%.The cost of equity is the required return on the equity investment, which is given as 15%. The cost of debt is the yield on the new debt issue, which is given as 10%.The tax rate is given as 40%.Therefore, the WACC is:WACC = (0.20 * 0.15) + (0.80 * 0.10) * (1 - 0.40) = 0.078 = 7.8%Therefore, the required return on the acquisition is 7.8%.

Needsalift, Inc. You Are Analyzing the Potential Acquisition of Nothing Better! Ice