Problemmagiclean corporation is considering the acquisition, Ask an Expert

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Problem:

Magiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02, and both it and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.

Required:

Question 1: What Dustvac's pre-merger WACC?

Question 2: What discount rate should you use to discount Dustvac's free cash flows and interest tax savings?

Question 3: What is the value of Dustvac's equity to Magiclean?

Note: Please show how you came up with the solution.

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Accounting Basics, Accounting

Category:- Accounting Basics
Reference No.:- M91168716

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