Firm A is a large firm in need of a new special technology department. Firm A currently has 900 million shares outstanding at a price of $20 per share. Firm A also carries perpetual debt of $1000 million. Firm B is a startup company that has the special technology needs that Firm A desires. Firm B currently has 10,000 shares outstanding that are owned by the founders. Firm B's pre-tax cash flows are $30million per year in perpetuity starting in one year. All financing (debt, equity, etc.) is conducted at rate of 10%, and the corporate tax rate is 40%.
Firm A can invest 500 million (a "research expense" which will be expensed immediately and tax deductible) to create their own special technology unit instead of acquiring Firm B.
a) What is the present value of the after tax cash flows at time = 1?
b) What is the present value of the after tax cash flows at time = 0?
Note: the after tax cash flows at time 0 will be financed like debt.
c) What is the present value (value added) from taking on additional debt?
d) What is the NPV of the project?