Reference no: EM133047992

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.

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