Magiclean Corporation Is Considering the Acquisition of Dustvac Company

question 14

Multiple Choice

Magiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02 , and both it and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.
-What Dustvac's pre-merger WACC?

• A) 9.02%
• B) 9.50%
• C) 9.83%
• D) 10.01%
• E) 11.29%

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Definitions:

Consideration

The value, such as money, promised, given, or done that induces a party to enter into a contract.

Society Duty

The ethical obligation or responsibility of individuals and organizations to act for the benefit of society at large, promoting social welfare and fairness.

Crime

An act prohibited by the state; a public wrong.

Exclusive Dealing

A contractual agreement where one party agrees to buy goods exclusively from another, often restricting competition.