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 $3.1 million indefinitely. The current market value of Teller is $76 million, and that of Penn is $130 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 $95 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?

Explanation / Answer

ATax annual CFs of $3.1M indefinitely is like a perpetuity. So PV of Perpetuity ie of Teller compaany is = A/i = $3.1M/10% = $31M a. Penn : If 40% of Stock is offered, its value is 40%*$76M = $30.4M So if Penn offers Stock, he is actually paying $30.4 for an asset worth $31M. thus gaining by $0.6M If Pen pays $95M, he is paying extra by 91-31 = $60M b. NPV of Stock is saving of $0.6M NPV of Cash is a Loss of 60M c. Penn shuld pay 40% stock.

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