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    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 Preview

    The question seems to be incomplete. It does not talk about the capital structure of the Eastern Pizza. The appropriate discount rate is ...

    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.