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Valdez Coffee Company is considering the cash acquisition of Mountain Creamery, Inc., for $750,000. The acquisition is expected to result in incremental cash flows of $100,000 in the first year, and this amount is expected to grow at a 6 percent compound rate. In the absence of the acquisition, Valdez expects net cash flows (after capital expenditures) of $600,000 this year, and these are expected to grow at a 6 percent compound rate forever. At present, suppliers of capital require a 14 percent overall rate of return for Valdez Coffee Company. However, Mountain Creamery is much more risky, and the acquisition of it will raise the company's overall required return to 15 percent.
a. Should Valdez Coffee Company acquire Mountain Creamery, Inc.?
b. Would your answer be the same if the overall required rate of return stayed the same?
c. Would your answer be the same if the acquisition increased the surviving company's growth rate to 8 percent forever?
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