Reference no: EM133027917

Question - Agility Inc., a U.S.-based corporation, wants to purchase Target Corp. Agility's management believes that the country in which Target is located is segmented from global capital markets.

Assumptions:

The current U.S. Treasury bond rate is 3%.

The expected inflation rate in Target's country is 5% annually, as compared to 2.5% in the U.S.

The country risk premium (CRP) for Target's country provided by S&P is estimated to be 2%.

Based on Target's interest coverage ratio, its credit rating is estimated to be AA. The current interest rate on AA-rated US corporate bonds is 4.5%.

Agility Inc. receives a tax credit for taxes paid in a foreign country.

Since its marginal tax rate is higher than Target's, Agility's marginal tax rate of 40% is used in calculating WACC.

Agility's pretax cost of debt is 4%. The firm's total capitalization consists only of common equity and debt. Acquirer's projected debt-to-total capital ratio is 0.3.

Target's beta and the country beta are estimated to be 1.2 and 0.8, respectively.

The equity premium is estimated to be 6% based on the spread between the prospective return on the country's equity index and the estimated risk-free rate of return.

Given Target Inc.'s current market capitalization of $3 billion, the firm's size premium (FSP) is estimated at 1.0.

What is the appropriate weighted average cost of capital (WACC) Agility should use to discount Target's projected annual local currency cash flows?