Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms h

Question

Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms have no debt. Penn believes the acquisition will increase its total aftertax annual cash flows by $1.9 million indefinitely. The current market value of Teller is $41 million, and that of Penn is $79 million. The appropriate discount rate for the incremental cash flows is 10 percent. Penn is trying to decide whether it should offer 40 percent of its stock or $57 million in cash to Teller’s shareholders. a. What is the cost of each alternative? b. What is the NPV of each alternative? c. Which alternative should Penn choose? a. Cash cost: Equity cost: Value of Teller: Value of Penn: Incremental annual cash flow: Discount rate: Stock offer: Post acquisition value of Teller: Equity cost: b. NPV Cash: NPV Stock: c. Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms have no debt. Penn believes the acquisition will increase its total aftertax annual cash flows by $1.9 million indefinitely. The current market value of Teller is $41 million, and that of Penn is $79 million. The appropriate discount rate for the incremental cash flows is 10 percent. Penn is trying to decide whether it should offer 40 percent of its stock or $57 million in cash to Teller’s shareholders. a. What is the cost of each alternative? b. What is the NPV of each alternative? c. Which alternative should Penn choose? a. Cash cost: Equity cost: Value of Teller: Value of Penn: Incremental annual cash flow: Discount rate: Stock offer: Post acquisition value of Teller: Equity cost: b. NPV Cash: NPV Stock: c.

Explanation / Answer

a)

Cash Cost = $ 57 Million

Since Cash flows go upto perpetuity, Value of target to the acquirer will be the value of target firm plus the present value of incremental cash flows associated.

Market Value of Target firm = $ 41 M + 1.9 M/ 0.1 = 41+ 19 M = $ 60 M

The cost of equity is the percentage of stock offering by Penn times the sum of market value of acquiring and target firm

Cost of Equity= 0.4*(60 + 79) = $ 55.6 M

b)

NPV for Cash Offer = -57 M + 60 M = $ 3M

NPV for Stock Offer = -55.6 + 60 M = $ 4.4 M

c)

Based on NPV analysis, Stock offer is the better offer.

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