Kubrick Company decides to buy Hitchcock Company. Both firms have the same characteristics of Walton Company(revenues of $1000, operating margin of 15%, a tax rate of 40%, investment rate of 8%, growth rate of 18%, and 5 years supernormal growth, and zero growth thereafter), except Kubrick Company has a beta of 1.2 and Hitchcock Co, has a beta of 1.4. Both firms have 30% debt and a cost of debt of 8%. Because of the nature of the synergies anticipated in the acquitistion, the combined firm is expected to have a beta of 1.1.
a.) If the risk-free rate is 6% and the equity risk premium is 5%, calculate the cost of capital for the two firms and the combined firm.
b.) Assuming the value drivers remain constant(and revenues are simply combined), what would be the value of the combined company?
This post calculates the cost of capital.