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Value of debt and tender offer

Company A has a tax rate of 20% and purchases and has a bond yielding 10%. What is Kd?

Lindbergh Airlines is planning to make an offer for Flight Simulators, Inc. The stock of Flight Simulators is currently selling for $30 a share.

a. If the tender offer is planned at a premium of 60 percent over market price, what will be the value offered per share for Flight Simulators?
b. Suppose before the offer is actually announced, the stock price of Flight Simulators, Inc., goes to $42 because of strong merger rumors. If you buy the stock at that price and the merger goes through (at the price computed in part a), what will be your percentage gain?
c. Because there is always the possibility that the merger could be called off after it is announced, you also want to consider your percentage loss if that happens. Assume you buy the stock at $42 and it falls back to its original value after the merger cancellation. What will be your percentage loss?

Solution Preview

Company A has a tax rate of 20% and purchases and has a bond yielding 10%. What is Kd?

Kd is the after tax cost of debt and is calculated as before tax cost X (1-tax rate). Here
before tax cost = 10%
tax rate = 20%
Kd = after tax cost of debt = 10% X (1-20%) = 8%

Lindbergh Airlines is planning to make an offer for Flight Simulators, Inc. The stock of Flight Simulators ...

Solution Summary

The solution explains how to calculate the after tax cost of debt and some calculations relating to tender offer.

$2.19