Dublin Medical (DM), a large established corporation with no growth in its real

Question

Dublin Medical (DM), a large established corporation with no growth in its real earnings, is considering acquiring 100% of the shares of Arlington Corporation, a young firm with a high growth rate of earnings. The acquisitions analysis group at DM has produced the following table of relevant data:

                                            Dublin Medical           Arlington

Earnings per share                    $3.00                     $2.00

Dividend per share                    $3.00                     $.80

Number of shares               200 million         10 million

Stock price                                    $30                     $20

DM's analysts estimate that investors currently expect growth of about 6% per year in Arlington's earnings and dividends. They assume that with the improvements in management that DM could bring to Arlington, its growth rate would be 10% per year beginning one year from now with no additional investment outlays beyond those already expected.

1. What is the expected gain from the acquisition?

2. What is the net present value (NPV) of the acquisition to DM shareholders if it costs an average $30 per share to acquire all of the outstanding shares?

3. Would it matter to DM's shareholders whether the shares of Arlington stock are acquired by paying cash or DM stock?

Explanation / Answer

1       rate is currently 6%, the constant growth rate DDM would imply that Trilennium

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