Question

Tango Company is planning to acquire Delta Company. The additional pre-tax income from the acquisition will be $300,000 in the first year, but it will increase by 2% in future years. Because of diversification, the beta of Tango will decrease from 1.2 to 0.8. Currently the return on the market is 9% and the riskless rate is 4%. What is the maximum price that Tango should pay for Delta

Answer 1

Complete question: Tax rate is 35%

Answer:

3250000

Explanation:

Tax income = 300000

Tax rate = 35%

Growth = 2%

Risk free rate = 4%

Expected market return= 9%

Beta = 0.8

We solve for the expected return on assets

= 4% + (9%-4%)x0.8

= 0.04+0.05*0.8

= 0.04 + 0.04

= 0.08

= 8% return on assets

The maximum price to pay

300000*(1-0.35)/(8%-2%)

= 300000 * 0.65/0.06

= 300000x10.8333333333

= 3,250,000