Question

Juicers Inc. is thinking of acquiring Fast Fruit Company. Juicers expects Fast Fruit's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Fast Fruit is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Fast Fruit will need $10 million of net new investment in operating capital. Fast Fruit's marginal tax rate is 40%. After the second year, the free cash flows and the tax shields from Fast Fruit to Juicers will both grow at a constant rate of 4%. Juicers has determined that Fast Fruit's cost of equity is 17.5%, and Fast Fruit currently has no debt outstanding. Assume that all cash flows occur at the end of the year, Juicers must pay $45 million to acquire Fast Fruit. What it the NPV of the proposed acquisition? Note that you must first calculate the value to Juicers of Fast Fruit's equity.

a. $86.5 million

b. $68.2 million

c. $45.0 million

d. $113.2 million

e. $133.0 million

Answer 1

Answer : a.$86.5 million

Calculation :

The unlevered cost of equity is 17.5%. All cash flows are discounted at this rate.

	Cash Flow	Discount @ 17.5%	Amount
Year 0	-45	1	-45
Year 1	9	0.851063829787	7.659574468085
Year 2	17	0.724309642372	12.31326392032
Year 2 (Terminal Value)	154	0.724309642372	111.5436849253
			86.5

Calculation of Cash Flow :

Year 1 : 9 (given)

Year 2 : 25 - 10 + 2 = 17

Year 2 (Terminal Value) = [(15+5)*1.04]/(0.175-0.04) ==> 154