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

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

-If the cost of debt increases to 12 percent,should Needsalift proceed with the acquisition?

A) No,with the debt cost at 12 percent,the value of the acquisition falls below $10 million by $853,000.
B) No,with the debt cost at 12 percent,the value of the acquisition falls below $10 million by $680,518.
C) Yes,since the increased cost of debt does not affect the value of the acquisition to Needsalift.
D) Yes,with the debt cost at 12 percent the value of the acquisition exceeds $10 million by $335,374.