Question

Suppose that Rose Industries is considering the acquisition of another firm in its industry for \$100...

Suppose that Rose Industries is considering the acquisition of another firm in its industry for \$100 million. The acquisition is expected to increase Rose's free cash flow by \$5 million the firs year, and this contribution is expected to grow at a rate of 3% every year there after. Rose currently maintains a debt to equity ratio of 1, its marginal tax rate is 40%, its cost of debt rD is 6%, and its cost of equity rE is 10%. Rose Industries will maintain a constant debt-equity ratio for the acquisition.

51. The Free Cash Flow to Equity (FCFE) for the acquisition in year 0 is closest to:

a. \$5 million

B. \$100 million

C. -\$100 million

D. -\$50 milllion

52. The Free Cash Flow-to-Equity (FCFE) for the acquisition in year 1 is closest to:

A. \$4.7 million

B. \$6.5 million

C. \$8.3 million

D. \$6.8 million

51) The free cash to equity will be = Cash from operating activites - Capital expenditure + New debt issued

Hence = -\$100Million + \$50millions = -\$50millions Option D

52)

As the company expects to maintain a growth rate of 3% yearly. and debt equity ratio has to be kept constant hence debt should be increased by 3% i.e. \$50M * 3% = \$1.5M

Interest of existing Debt = \$50M * 6% = \$3M

Interest after Tax = \$3M * (1-40%) = \$1.8M

CAsh from operating activity = \$5M -\$1.8M = \$3.2M

FCFE = Cash from operating activites(\$3.2M) - Capital expenditure(0) + New debt issued(\$1.5M)

FCFE = \$4.7M

Option A

and firm is going to maintain same debt equity ratio. hence Incremental value of debt will be \$50Million

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