Multiple Choice
Great Subs Inc., a regional sandwich chain, is considering purchasing a smaller chain, Eastern Pizza, which is currently financed using 20% debt at a cost of 8%. Great Subs' analysts project that the merger will result in incremental free cash flows and interest tax savings of
$2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and
$117 million in Year 4. (The Year 4 cash flow includes a horizon value of $107 million.) The acquisition would be made immediately, if it is to be undertaken. Eastern's pre-merger beta is 2.0, and its post- merger tax rate would be 34%. The risk-free rate is 8%, and the market risk premium is 4%. What is the appropriate rate for use in discounting the free cash flows and the interest tax savings?
A) 12.0%
B) 13.9%
C) 14.4%
D) 16.0%
E) 16.9%
Correct Answer:
Verified
Correct Answer:
Verified
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