7) M&A. For this and the next 2 questions: Magiclean Corporation is considering

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7) M&A. For this and the next 2 questions: Magiclean Corporation is considering an acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) in 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 percent 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 four 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. Additionally, 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% and the market risk premium is 4%. Dustvac's pre-merger WACC is 9.83%.

7) Under the APV approach, calculate unlevered cost of equity using the following formula: wdrd + wErEL.

A) 10.01%

C) 11.29%

D) 11.44%

E)   13.49%

9) Residual Dividend Policy. For this and the next question: Caesar Machinery is a large machine shop in the southeast side of town. The company's capital budget for the next fiscal year is $60 million. Its optimal capital structure calls for a debt ratio of 60%. The company's earnings before interest and taxes (EBIT) are $98 million for the year. The firm has $200 million in assets, pays an average interest of 10% on all its debt, and has a marginal tax rate of 35%. The firm maintains a residual dividend policy and will keep its optimal capital structure intact. Calculate the company's net income.

A) $98 Million

C) $55.90 Million

D) None of the above

10) Calculate the dividend amount after the financing of the company's capital budget.

A) $36 Million

C) $31.90 Million

D) $55.90 Million

Explanation / Answer

7. The Weight of debt = Wd = 5/15 = 0.3333

Weight of Equity = We = 1-0.3333 = 0.6667

The cost of debt = 11%. So after tax cost = 11*(1-0.4) = 6.6%

WACC = 9.83%

So WACC = WdRd + WeRe

9.83 = 0.3333* 6.6 + 0.6667 Re

Re = 7,63022/0.6667 = 11.44%

Answer is Option D : 11.44%

9 The Net Income is calculated as follows

Net Income = 55.9 Million (Option C)

10. The amount to be financed from retaine earnings is 100-60 = 40%

So. 40% of 60 Million = 24 Million

So the amount of dividend = 55.90 - 24 = 31.90 (Option A)

EBIT 98000000 Interest on debt 12000000 EBT 86000000 Tax at 35% 30100000 Net Income 55900000

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