DustvacMagiclean Corporation Is Considering the Acquisition of Dustvac Company

question 18

Multiple Choice

DustvacMagiclean 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%.
-Refer to Scenario: Dustvac.What discount rate should you use to discount Dustvac's free cash flows and interest tax savings?

• A)10.01%
• B)10.06%
• C)11.34%
• D)11.44%

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Definitions:

Selling

The process of persuading someone to purchase a product or service, involving various techniques to close sales.

Renting

The process of leasing or borrowing an asset or property for a specified period of time in exchange for a fee.

Ultimate Consumers

The end users of a product or service who are not looking to resell it; the final buyers.

Retail Outlet Classification

The categorization of retail stores based on factors such as size, location, product range, and sales method.