What is Raider Blowers’ pre-merger WACC?

Gordon Investments Inv. (a private equity firm) is considering the acquisition of Raider Blowers Inc. Raider Blowers has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Raider Blowers’ pre-merger beta is 1.36. Best’s beta is 1.02, and both it and Raider Blowers face a 40% tax rate. Best’s capital structure is 40% debt and 60% equity. The free cash flows from Raider Blowers are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.

a. (4 pts) What is Raider Blowers’ pre-merger WACC?

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b. (5 pts) What discount rate should you use to discount Raider Blowers’ free cash flows and interest tax savings?

 

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