4. Great Subs, Inc., a regional sandwich chain, is considering purchasing a smaller chain, Eastern Pizza, ,which is currently financed using 20% debt at a cost of 8%. Great Subs’ analysts project that the merger ,will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year ,2, $5 million in Year 3, and $117 million in Year 4. (The Year 4 cash flow includes the horizon value of ,$107 million.) The acquisition would be made immediately, if it is to be undertaken. Eastern’s pre-merger ,beta is 2.6, and its post-merger tax rate would be 34%. The risk-free rate is 8%, and the market risk ,premium is 4%. What is the appropriate rate to use in discounting the free cash flows and the interest ,tax savings if you use the Adjusted Present Value approach?
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