Smart Products plans to acquire Snazzy Snaps, which will create $8 million in incremental cash flows for Smart each year for the first six years. Smart Products plans to divest Snazzy Snaps at the end of the sixth year for $112,500,000. Smart’s beta (b) is 1.2, and is expected to remain so after the acquisition. The risk free rate is 5 percent and the expected return on the market is 16 percent. Smart Products has a 100 percent equity capital structure which will be maintained post-acquisition.
a. What is Smart Products’ cost of equity?
b. If Smart Products’ beta (b) falls to 0.95 post-acquisition, what would its weighted average cost of capital be?
c. What is the maximum price Smart Products can pay for Snazzy Snaps?