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Kellogg's wants to expand its cereal business by acquiring Major foods company. Kellogg's currently has debt outstanding with a market value of $150 million and a YTM of 7 percent. The company's market capitalization is $390 million, and the required return on equity is 12 percent. Major foods has debt outstanding with a market value of $32 million. The EBIT for Major Foods is projected to be $14 million. EBIT is expected to grow at 11 percent per year for the next five years before slowing to 2 % in perpetuity. Net working capital, capital spending, and depreciation as a percentage of EBIT are expected to be 10 percent, 15 percent, and 9 percent, respectively. Major Foods has 2 million shares outstanding, and the tax rate for both companies is 40 percent.
Question (a). What is the maximum share price Kellogg's should to pay for Major foods stock.
Question (b). Would you recommend that Kellogg's purchase Major foods? Why?
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