Company A (with a current market cap of $79 million) is analyzing the possible a

Question

Company A (with a current market cap of $79 million) is analyzing the possible acquisition of Company B (with a current market cap of $41 million). Neither firm has any outstanding debt. Company A believes that the acquisition will increase its total after tax annual cash flows by $1.9 million indefinitely. You may assume that the appropriate discount rate for the incremental cash flows is 10%. Company A is contemplating whether to make a $57 million cash offer or if it should offer 40% of its stock to Company B shareholders.

(a) What is the cost of each alternative?

(b) What is the NPV of each alternative?

(c) Which alternative should Company A choose?

Explanation / Answer

(a) Cost Cash alternative 57 Stock alternative (79 x 40%) 31.6 (b) NPV = cost - Value of Company B Value of company B = Pv of post tax incremental cash flows Vb = 1.9/.1 = 19 (Because it is perpetual) NPV - Cost Cash alternative Stock alternative Cost 57 31.6 Less: Value of B 19 19 NPV - 38 12.6 (c ) Cash alternative is better as it provides more NPV. Please provide feedback…. Thanks in advance…. :-)

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