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Net Present Value: Probability, Tax, Debt, Capital, and Equity

1. Possible net present values and associated probabilities for a new investment are as follows:
NPV -1020 -800 80 450 550 800
Probability .15 .30 .20 .10 .10 .15
What is the expected value______________, median,______________ and mode _________________?

2. You have been given the job of evaluating the following merger candidate. You have collected the following cash flow for the acquisition candidate for the proposed merger (in millions):
Year 1 2 3 4 5
Cash flows now 80 85 105 145 180
Additional cash flows with merger 40 90 100 125 150
Total cash flows with merger 120 175 205 270 330

Risk free rate of return 3.5%
Beta for this project (the company after merging) 1.6
Market risk premium 5%
Pre-tax cost of debt 7.5%
Marginal tax rate 30%
Number of shares outstanding for the target company (millions) 55
Current market price per share for the target company $60
Percentage of the acquisition financed with debt 50%
Percentage of the acquisition financed with common equity 50%

What is the after tax cost of debt?

What is the after tax cost of common equity

What is the weighted average cost of capital for this acquisition candidate?

What is the maximum price per share you are willing to pay for this candidate?

Based on the numbers above, would you pursue this candidate?

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Solution Summary

This solution illustrates how to compute the expected value, median and mode of a project based upon its net present values and the probability of each. It also illustrates how to compute the after-tax cost of debt, cost of common equity, weighted-average cost of capital, net present value, and maximum price to pay for a merger candidate.