Appropriate Discount Rate for Acquisitions
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Please help with the following problem.
American Pizza, a national pizza chain, is considering purchasing a smaller chain, Eastern Pizza. American's analysts project that the merger will result in incremental net cash flows 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 cashflow includes a terminal value of $107 million.) The acquisition would be made immediately if it is undertaken. Eastern's post-merger beta is estimated to be 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 discount rate for valuing the acquisition?
a. 17%
b. 16%
c. 15%
d. 14%
e. 12%
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Solution Summary
This solution identifies the appropriate discount rate and shows step-by-step calculations to determine the cost of equity. Step by step calculations are given.
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The question seems to be incomplete. It does not talk about the capital structure of the Eastern Pizza. The appropriate discount rate is ...
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