Question

Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms have no debt. Penn believes the acquisition will increase its total after-tax annual cash flows by $3.1 million indefinitely. The current market value of Teller is $78 million, and that of Penn is $135 million. The appropriate discount rate for the incremental cash flows is 12 percent. Penn is trying to decide whether it should offer 40 percent of its stock or $94 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?

Answer 1

a.

The two alternatives are

payment with cash

payment with stock.

cost of the cash = $94 mil.

The cost of the stock payment is:

Stock Value =40% ∗Value of combined firm

Value of stock=40% ∗(Value of (Penn+ Teller+synergy))

Value of stock=40%∗(135 +78 +3.1/12%) = $ 95.53

b.

The value of the acquisition is:

acquisition value = Value ( Teller+synergy)

Value of acquisition=78 + 25.83 = 103.83

Therefore the NPV cash purchase = -94 + 103.83 = $9.83 mil.

The value of the stock purchase is - 95.53 + 103.83= $8.3 mil

c.

They should choose the cash purchase due to its higher NPV