Evaluate the after tax cost of debt


Question 1. Possible net present values and associated probabilities for a new investment are as follows:

NPV            -1020 -800    80    450    550    800
Probability    .15    .30     .20    .10    .10     .15

What is the expected value______________, median,______________ and mode _________________?

Question 2. You have been given the job of evaluating the following merger candidate. You have collected the following cash flow for the acquisition candidate for the proposed merger (in millions):

Year                                              1       2       3       4        5
Cash flows now                             80      85    105    145    180
Additional cash flows with merger   40      90    100    125    150
Total cash flows    with merger      120    175    205    270    330

Risk free rate of return 3.5%
Beta for this project (the company after merging)    1.6
Market risk premium 5%
Pre-tax cost of debt    7.5%
Marginal tax rate    30%
Number of shares outstanding for the target company (millions)    55
Current market price per share for the target company    $60
Percentage of the acquisition financed with debt 50%
Percentage of the acquisition financed with common equity    50%

What is the after tax cost of debt?

What is the after tax cost of common equity

What is the weighted average cost of capital for this acquisition candidate?

What is the maximum price per share you are willing to pay for this candidate?

Based on the numbers above, would you pursue this candidate?

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Finance Basics: Evaluate the after tax cost of debt
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