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 $3 million indefinitely. The current market value of Teller is $48 million, and that of Penn is $90 million. The appropriate discount rate for the incremental cash flows is 10 percent. Penn is trying to decide whether it should offer 45 percent of its stock or $73 million in cash to Teller's shareholders.

a.	What is the cost of each alternative? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Cash cost	$
Equity cost	$

b.	What is the NPV of each alternative? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

NPV cash	$
NPV stock	$

c.

Which alternative should Penn choose?

	Cash
	Stock

Answer 1

a)

in cash alternative cost is amount paid in cash = $73,000,000

Equity cost:

Total stock value after acquisition = (90,000,000 + 48,000,000 + (3,000,000 / 10%)) = 168,000,000

cost = 45% of above value

Equity cost = 168,000,000* 45% = $75,600,000

b)

NPV = value of the teller company - cost

value of the teller company = 48,000,000 +(3,000,000/10%) = 78,000,000

NPV cash = 78,000,000 - 73,000,000 = $5,000,000

NPV Stock = 78,000,000 - 75,600,000 = $2,400,000

c)

Yo can see from above that cash option has high NPV so answer is cash