Needsalift, Inc. You Are Analyzing the Potential Acquisition of Nothing Better! Ice

question 60

Multiple Choice

Needsalift, Inc.
You are analyzing the potential acquisition of Nothing Better! Ice Creams, Inc. by your firm, Needsalift, Inc. The ice cream firm is a wholly owned subsidiary of Grand Lake Investments, which has set a firm selling price of $10,000,000. From your work you estimate that Nothing Better! will generate the following incremental cash flows for Needsalift:

Year Incremental Cash Flow
1 $1,000,000
2 $1,500,000
3 $3,000,000
4 $4,000,000
5 $4,500,000

To fund the $10 million price, Needsalift can use $2 million from internal sources (retained earnings) with a required return of 15 percent, while the rest would come from a new debt issue yielding 10 percent. Needsalift’s tax rate is 40 percent

-If the cost of debt increases to 12 percent,should Needsalift proceed with the acquisition?

• A) No,with the debt cost at 12 percent,the value of the acquisition falls below $10 million by $853,000.
• B) No,with the debt cost at 12 percent,the value of the acquisition falls below $10 million by $680,518.
• C) Yes,since the increased cost of debt does not affect the value of the acquisition to Needsalift.
• D) Yes,with the debt cost at 12 percent the value of the acquisition exceeds $10 million by $335,374.

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Definitions:

Relative

An item or factor considered in relation or in proportion to something else.

Not Absolute

Suggesting that something is subject to change or can be viewed in different ways, not fixed or definite.

Competitive Advantage

A condition or circumstance that places a company in a superior business position compared to its competitors, often resulting from unique resources, capabilities, or strategies.

Advantage

A favorable or beneficial condition, circumstance, or position that improves one's ability to achieve success.