Cash acquisition decision Luxe Foods is contemplating acquisition of Valley Canning Company for a

QUESTION

Cash acquisition decision Luxe Foods is contemplating acquisition of Valley Canning Company for a cash price of $180,000. Luxe currently has high financial leverage and therefore has a cost of capital of 14%. As a result of acquiring Valley Canning, which is financed entirely with equity, the firm expects its financial leverage to be reduced and its cost of capital to drop to 11%. The acquisition of Valley Canning is expected to increase Luxes cash inflows by $20,000 per year for the first 3 years and by $30,000 per year for the following 12 years.a. Determine whether the proposed cash acquisition is desirable. Explain your answer.b. If the firms financial leverage would actually remain unchanged as a result of the proposed acquisition, would this alter your recommendation in part a? Support your answer with numerical data.
If the acquisition was made the leverage would come down from 14% to 11% hence the Net present value of the firm would be, Years 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Cash Price (in the form of acquisition) ($) -1,80,000 Cash Inflows ($) 20000 20000 20000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 Discount rate 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Presen value ($) -180000 18018.02 16232.45 14623.83 19761.93 17803.54 16039.23 14449.75 13017.79 11727.74 10565.53 9518.499 8575.225 7725.428 6959.845 6270.13 NPV ($) 11288.94 Yes the proposed acquisition is desirable as the NPV is positive. B) if the leverage does not change and remains in the 14% area then the NPV would be, Years 0 1 2 3 4 5 6 7 8

9 10 11 12 13 14 15 Cash Price (in the form of acquisition) ($) -1,80,000 Cash Inflows ($) 20000 20000 20000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 Discount rate 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% Presen value ($) -180000 17543.86 15389.35 13499.43 17762.41 15581.06 13667.6 11989.12 10516.77 9225.238 8092.314 7098.521 6226.773 5462.082 4791.3 4202.894 NPV ($) -18951.3 Since the NPV is negative so the proposed acquisition is undesirable

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