Question

Penn Corporation is analysing the possible acquisition of Teller Company. There are two alternatives for Penn: to use cash or stock as payment. Both firms have no debt. Penn believes the acquisition will increase its total after-tax annual cash flow by €1.3 million indefinitely. The current market value of Teller is €27 million, and that of Penn is €62 million. The appropriate discount rate for the incremental cash flows is 11 percent. Penn is trying to decide whether it should offer 35 percent of its stock or €37 million in cash to Teller’s shareholders.

Instructions:

1. What is the cost of each alternative? (5 points)

2. What is the NPV of each alternative? (5 points)

3. Which alternative should Penn choose? (5 points)

4. What are some important factors in deciding whether to use stock or cash in an acquisition? (5 points)

5. Explain what defensive tactics the managers of Teller Company could use to resist acquisition. (5 points)

Answer 1

Below are the answers.

Explanation:

Answer a.

Cost of Cash: €37,000,000

Cost of equity = ( (62000000 + 27000000) + (1300000/11%) ) * 35%

= €35,286,364

Answer b.

NPV of cash = (27000000 + (1300000/11%) ) - 37000000

= €1,818,182

NPV of equity = (27000000 + (1300000/11%) ) - 35286364

= €3,531,817

Answer c.

You should pick stock option.

Answer d.

Through purchase option, the acquirer and purchaser bear the burden of competition, so capital flow does not occur. The acquirer has no cash to pay.

Answer e.

Quite common averting strategies: Only a few directors can be elected by the company, and voting can be delayed Company may bring a friendly company before takeover to buy controlling interest.Company may buy back particular number of shares at a premium from individual investors to avoid takeover because the valuation inflates.

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