Problem:
Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker'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, Laker is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Laker will need $10 million of net new investment in operating capital. Laker's marginal tax rate is 35%. After the second year, the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 6%. Blazer has determined that Laker's cost of equity is 16.5%, and Laker currently has no debt outstanding. Assume that all cash flows occur at the end of the year and that Blazer must pay $50 million to acquire Laker.
Required:
Question: What is the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.
Note: Provide support for your rationale.