A firm is considering acquiring a competitor.The firm plans on offering $200 million for the competitor.The firm will need to issue new debt and equity to finance the acquisition.You estimate the issuance costs to be $10 million.The acquisition will generate an incremental free cash flow of $25 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever.If the firm's WACC is 13%,what is the value of this project?
A)$40 million
B)$50 million
C)$60 million
D)$70 million
E)$80 million

Question

Quizplus · Accepted Answer

The value of the project is the present value of the incremental free cash flows. The incremental free cash flow in the first year is $25 million, and it is expected to grow at an annual rate of 3% forever. The WACC is 13%. Therefore, the value of the project is:PV = $25 million / (0.13 - 0.03) = $250 millionThe issuance costs are $10 million, so the net value of the project is $250 million - $10 million = $240 million. The firm is offering $200 million for the competitor, so the value of the project to the firm is $240 million - $200 million = $40 million.

A Firm Is Considering Acquiring a Competitor