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bank 3009 corporate valuation and risk management

You have the following initial information on Financeur Co. on which to base your calculations and discussion for questions 1) and 2):

Current long-term and target debt-equity ratio (D:E) = 1:3

Corporate tax rate (TC) = 30%

Expected Inflation = 1.55%

Equity beta (E) = 1.6345

Debt beta (D) = 0.15

Expected market premium (rM rF) = 6.00%

Risk-free rate (rF) =2%

2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyout of Financeur Co. to allow them to integrate production activities. The potential acquiring firms management has approached an investment bank for advice. The bank believes that the firm can gear Financeur Co. to a higher level, given that its existing management has been highly conservative in its use of debt. It also notes that the customers firm has the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations.

a) What would the required rate of return for Financeur Co.s equity become if the proposed gearing structure were adopted following acquisition by the customer?

b) Would the above project described in 1) be viable for the new owner of Financeur Co.? Justify your answer (numerically).

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