Problem:
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 first year, and this contribution is expected to grow at a rate of 3% every year thereafter. Rose currently maintains a debt-to-equity ratio of 1, its marginal tax rate is 40%, its cost of debt is equal to 6%, and its cost of equity is equal to 10%. Rose Industries will maintain a constant debt-to-equity ratio for the acquisition.
(a) Rose's unlevered cost of capital is closest to:
(1) 8.0%
(2) 7.5%
(3) 7.0%
(4) 9.0%
(b) The unlevered value of Rose's acquisition is closest to:
(1) $63 million
(2) $50 million
(3) $167 million
(4) $100 million
Note: Explain all steps comprehensively.