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Fessenden Corporation has accumulated a significant amount of debt as a result of debt-financed acquisitions of other companies. It is currently considering acquiring one of its competitors, Sonar Corporation. Fessenden's existing debt covenants stipulate that it cannot go beyond a debt to equity ratio of 1.25:1 and a net debt as a percentage of capitalization ratio of 0.90:1. The acquisition of Sonar will cost $83 million. Fessenden's current level of equity is $440 million and its current level of interest-bearing debt is $563million. Fessenden has a cash balance of $79 million. It will finance the acquisition with a 10-year bond of $83 million that carries a 5% interest rate sold at par.
Problem 1: Determine Fessenden's debt to equity ratio and net debt as a percentage of capitalization ratio prior to the proposed acquisition.
Problem 2: Determine whether Fessenden could acquire Sonar Corporation with the bond issue and still remain in compliance with the existing debt covenants.
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