An all-equity financed company has a cost of capital of 12 percent. It owns only one project with a an economic life of 5 years. The project is expected to be abandoned at the end of its economically useful life. The project is capable of generating $200 million in free cash flow every year for five years, at which time it will be abandoned with zero liquidation value. A buyout firm proposes to purchase the company for $800 million financed with $700 million in debt to be repaid in five, equal, end-of year payments and carrying an interest rate of 5%.

A. Ignoring taxes, estimate the rate of return to the buyout firm on the acquisition after debt service.

B. Assuming the company’s cost of capital is 10 percent, does the buyout look attractive? Why, or why not