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

Question

Quizplus · Accepted Answer

1. Calculate the value of Fast Fruit's equity:
Year 1: NOPAT = $9 million
FCF = $9 million
Year 2: NOPAT = $25 million
Interest expense = $5 million
Net Income = $20 million
FCF = ($20 million + $5 million - $10 million) = $15 million
Value of Fast Fruit's equity at the end of year 2 = ($15 million / (0.175 - 0.4 * 0.175)) = $75 million

2. Calculate the present value of Fast Fruit's cash flows to Juicers:
PV of Year 2 cash flows = ($15 million * 1.04) / (0.175 - 0.4 * 0.175 - 0.04) = $143.05 million
PV of tax shields = ($5 million * 0.4) / (0.175 - 0.4 * 0.175 - 0.04) * (1 - 0.4) = $12.51 million
Total PV of Fast Fruit's cash flows to Juicers = $155.56 million

3. Subtract the cost of the acquisition from the present value of Fast Fruit's cash flows to Juicers:
NPV of the proposed acquisition = $155.56 million - $45 million = $110.56 million

Therefore, the best choice is option C.