Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms h

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 $2 million indefinitely. The current market value of Teller is $55 million, and that of Penn is $87 million. The appropriate discount rate for the incremental cash flows is 10 percent. Penn is trying to decide whether it should offer 40 percent of its stock or $64 million in cash to Teller's shareholders. 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 & 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 $ Which alternative should Penn choose Cash Stock

Explanation / Answer

Gain on acquisition = $2 million/10% or $2 million/0.10

= $20 million

a)

Equity cost:

Total market value of Penn after acquisition = $55 million + $87 million + $20 million

= $162 million

Offer value to teller = $162*40/100

= $64.80 million

Cost = $64.80 - $55

= $9.8 million

Cash cost:

Offer value to Teller = $64

Cost $64 - $55

= $9 million

b)

NPV stock:

NPV to Penn = Gain - Cost

= $20 - $9.8

= $10.2

NPV cash:

NPV to Penn = Gain - Cost

= $20 - $9

= $11

c)

Penn should shoose the alternative of cash due to more NPV.

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