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Stephens Supply Company (SSC) is a conservative firm with a market value of $100 million and...

Stephens Supply Company (SSC) is a conservative firm with a market value of $100 million and a market beta of 0.4. The risk-free rate is 3% and the market risk premium is 6%. SSC believes they can create value by taking over riskier firms and reducing their cost of capital. SSC is considering buying another firm for $10 million and expects the firm will be worth $11 million next year (expected return is 10%). The new firm has a market beta of 2. What is the NPV of buying the other firm? What is the beta of the combined firm? What is the combined firm’s cost of capital? What is the value of the combined firm?

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Answer #1

✓ NPV = $0

✓ Combined beta = 0.5456

✓ Combined cost of capital = 5.82%

✓ Value of combined firm = $ 110 million

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