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You are analyzing the potential acquisition of Nothing Better! Ice Creams, Inc. by your firm, Needsalift, Inc.

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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.
a. What is the required return on the acquisition of Nothing Better! for Needsalift?
b. What is the value of the proposed acquisition to Needsalift?
c. If the cost of debt increases to 12 percent, should Needsalift proceed with the acquisition?
d. If the project were financed completely with equity (retained earnings) and the required return remained unchanged post-acquisition, what is the most Needsalift would be willing to pay for Nothing Better! Ice Creams?



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