In late 1999 the company was evaluating a plan to acquire a Hongkong company, Feng-Shui Compass Co. The Director of Finance, Widjojo Nugroho, had recently been hired away from Bank Bumi Daya in Jakarta in order to bring modern financial management techniques to Fakawi and to prepare the company for an initial public offering.

A few months earlier, Nugroho had attended a course on corporate finance in Singapore, and he was determined to apply modern principles of valuation to to proposed acquisition. He estimated that the purchase of Feng-Shui would result in $25 million of incremental operating revenues for the Fakawi group in each of the first 5 years. However, Fakawi would have to assume Feng-Shui's existing debt and borrow another $23 million to finance the acquisition. This would, Nugroho estimated, result in $15 million of additional debt servicing costs per annum. Since interest and depreciation are tax deductable in Indonesia, the acquisition would generate approximately $5 million in tax shields each year. Nugroho decided to examine the deal on the assumption that Fakawi would to divest the target in year 6 for $100 million. 

Since the Soegondho family had internationally-diversified investments, Nugroho felt the valuation should be done in the context of the more efficient U.S. market rather than the Jakarta exchange. He found that the risk-free rate, the Treasury note yield, was 6%, and the S&P expected return was 16%. Fakawi's Hongkong advisors, Jardine Fleming, estimated that Feng-Shui had a beta of 1.3 (again, measured with respect to the U.S. market). For their M&A advice, Jardines was charging a fee of 2% of the acquisition price. 

Assignment: What is the source of potential value creation in this acquisition? What was the maximum price that Fakawi should offer for Feng-Shui? How should the acquisition be financed?