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 $1.9 million indefinitely. The current market value of Teller is $41 million, and that of Penn is $79 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 $57 million in cash to Teller’s shareholders.
a) What is the cost of each alternative?
b) What is the NPV of each alternative?

Explanation / Answer

a. 40% of its stock will be 79 + 41 = 120 Million since they are a merged entity no. So 40% of this stock means Penn will pay to the Tellers stock holders= 0.4* 120 Million = 48 Milliom = 48,000,000 = 48 Million = 48,000,000.

So the additonal cost of this alternative(stock( will be 48,000,000 - 41,000,000(original value of Tellor) = 7,000,000

The cost of offering cash is =57,000,000.

So additonal cost of this alternative (cash( will be = 57,000,000 - 41,000,000 = $16,000,000

b. NPV of offering stock = PV of future cashf low/ discount rate - 7,000,000

NPV of offering stock = 1,900,000/0.10 - 7,000,000 = 12,000,000

NPV of offering Cash = 1,900,000/0.10-16,000,000 = 3,000,000

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