Question

The Bucket Company (Bucket) is evaluating acquiring The Shovel (Shovel) company to expand its product offering.  The acquisition would cost Bucket $155 million.  Bucket believes that Shovel would increase its annual cash flows by $12 million for the 20 years, at which point the company will explode.

A quick look at Bucket’5s Balance Sheet (January 31, 2019) and you find the following information:

• Bonds Payable – Maturity Date Jan 31, 2035, $100

Coupon paid semi annually, $1,000 Par Value       $95,000,000

• Common Shares – 500,000 shares outstanding          $55,000,000
• Preferred Shares – $100 par value – 8% cumulative

200,000 outstanding                      $18,980,000

A quick look at a financial website gives you the following information:

• Current Price of a Bucket’s Bond is $987.48
• Current Price of a Bucket’s Common Share is $107.35 and it has a Beta of 1.3
• Current Price of a Bucket’s Preferred Share is $98.77
• A fiveyear fixed GIC is 2.5%
• Over the past 10 years the TSX has had an annual return of 10%
• Bucket’s Tax Rate is 30%

Required: Based on a Net Present Value calculation, financially speaking, should Bucket acquire Shovel?

Answer 1

The Solution is handwritten and please check the Image Uploaded.

PAGE SOLUTION Calculation of Net Present value Tuitial Cash Outflow $155 Million Present value of Annual Cash Luflows $120llioux PVAc (5.884., 32) $12X Million x 14.274 171. 29 Million - NPV + $ 16.29 Million CONCUSION! Bucket should acquire shovel as it will give positive NPV of $16.29 Million WORKING NOTE: Five year GiC 2.5% = Rd Market Return (Rm) 10% Beta of Equity → 1.3 Ke = Rft Beta (RM-RJ) Edisy.+ 13 (104. - 2.5%) => 12.259 Kd = Rj = 2.5% Kp = 8%. Calculation of WACC Kex We + kd x Wd & kpx wp 12:25 X 55.00.0000 + 7.5 x 95,000,000 + 8 x 20,000,000 170,000,000 170,000,000 170,000,000 = 5.884. Weights Equity = 55,000,000 Boef shock = 20,000,000 Bond = 95,000,000 170,000,000