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General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate...

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Finance

General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate WACC for discounting the projected cash ows for Hughes was dierent from its WACC, GM assumed that Hughes was of approximately the same risk as Lockheed or Northrop. Consider the following information:

image

Target D/E for acquisition of Hughes = 1

Hughes expected unlevered cash ow next year = $300 million

Growth rate of cash ows for Hughes = 5% per year

Corporate tax rate = 34%

All corporate debts are risk free, static and perpetual Risk free rate = 8%

Expected return of the market portfolio = 14%

Question)

Apply the APV method:

(a) Value of the unlevered assets of Hughes

(b) PV of the tax shield

Comparison Firm BE D/E- t GM- 1.20 0.40+ 0.90 0.90+ + Lockheed Northrop- 0.85- 0.70

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