Q1. The management of Cyclical Industries, Inc. is considering acquiring Stable

Question

Q1.

The management of Cyclical Industries, Inc. is considering acquiring Stable Products Corp. Both firms are large, publicly-traded U.S. manufacturing firms. Cyclical Industries has volatile sales from year to year, while Stable Products is a steady revenue generator. What can we reasonably conclude about this acquisition?

I. It is probably the best way for the shareholders of Cyclical Industries to diversify firm-specific risk
II. It may create value if it adds debt capacity to the combined firms
III. It may cause the share value of Stable Products to decline on the acquisition announcement

Select one:

A. I only

B. II only

C. I and II only

D. I and III only

E. II and III only

F. I, II, and III

Q2.

Smart Ideas, Inc. has been underperforming its industry peers for quite some time. You are attempting to determine the value of control and have the following information available:

Smart Ideas, Inc.:
Dividend Payout Ratio = 40%
Beta = 1.00
Growth Rate = 5.00%

Peer Group:
Dividend Payout Ratio = 50%
Beta = 1.30
Growth Rate = 8.00%

Smart Ideas, Inc. generated $3.00 of earnings per share in the current year. The T-bill rate of return is 4.00% and the market rate of return is 10.00%. What is the per share value of Smart Ideas, Inc.'s stock without managerial control?

Select one:

A. $12.69 per share

B. $25.20 per share

C. $31.50 per share

D. $41.15 per share

E. None of the above

Explanation / Answer

Answer :

Question 1.C. I and II only

Question 2.B. $25.20 per share

Earnings x payout ratio = Dividend ; 3 x 0.4 = 1.20

Dividend = 1.20 * 1.05 = 1.26

Cost of Equity = Tbill rate + beta (Market return - Tbill rate)

Cost of Equity = 4% + 1 (10% - 4%) = 10%

Share price = D1 / (ke - g) = 1.26 / ( 10% - 5%) = $ 25.20 per share.

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