Question

Fly-by-night couriers is analyzing the possible acquisition of flash-in-the-pan restaurants. Neither has any debt. The forecasts by Fly-by-Night show that the purchase would increase total annual after tax cash flows by $600,000 indefinitely. The current market value of Flash-in-the-pan is $10 Million. The current market value of Fly-by-night is $35 Million. The appropriate discount rate for any change in cash flows form the merger is 8 percent.

We argued that makiing an issue easier to sell was a legitimate reason to underpice an issue.

A) True

B) False

C) not enough info

Answer 1

The value for Fly-by night is = Annual pepetual cash flows/ discount rate = 600,000/0.08 = 7,500,000

So the current market value of 10 Million is higher than the value that can be relaized by Fly-by-night which ids 7,500,000

So, this acquisition becomes profitable for Fly-by night at a lower than 7.5 Million

With regards to rasing new capital, yes unbderpricing attracts more investors to the issues so that then can make up the true value. Since here the true value is only 7.5 Million, you should price the issue in such a manner that the total cost is lower than 7.5 Million for investors to subscribe to the issue.

So, I would say this is TRUE