Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target company’s equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the target’s cash flows and sell it for 12 times
| ($ millions) | |||||||
| Year | 1 | 2 | 3 | 4 | 5 | ||
| Free cash flows | $38 | $53 | $58 | $63 | $ | 63 | |
| Selling price | $ | 756 | |||||
| Total free cash flows | $38 | $53 | $58 | $63 | $ | 819 | |
To finance the purchase, the investors have negotiated a $530 million, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition.
| Selected Additional Information | ||
| Tax rate | 40 | percent |
| Risk-free interest rate | 3 | percent |
| Market risk premium | 5 | percent |
d. Estimate the
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