Q2) List types of acquisition and discus each one? Q3) STC Internet, Inc. is eva
ID: 2790899 • Letter: Q
Question
Q2) List types of acquisition and discus each one?
Q3) STC Internet, Inc. is evaluating its cost of capital under alternative financing arrangements. In consultation with investment bankers, STC expects to be able to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of STC is currently selling for $20.00 a share. STC expects to pay a dividend of $1.50 per share next year. Market analysts foresee a growth in dividends in Invest stock at a rate of 5% per year. STC marginal tax rate is 35%.
a. If STC raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is STC cost of capital?
b. If STC raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is STC cost of capital?
Q4) What are the determinants of option values?
Explanation / Answer
An acquisition normally occurs when a company acquires another company by taking over its operations in exchange for cash or stock or both. There are different types of acquisition or merger
a) Horizontal Merger
A kind of merger where both the acquirer and target may have similar product lines and similar customer profile so that the combined entity can deliver better value to customers as well as themeselves. The word used here is synergy in operations. ie (1+1>2) is the norm here. This is mainly done to thwart competitors, increase market share , topline and bottomline, improve economies of scale etc.
b) Vertical Merger
Vertical Merger occurs when the acquirer and target are in the same value chain of production or service process. This kind of acquistion helps when a company wants to have least issues with respect to supplier problems and secure supply of needed goods. For example a retail clothing store acquiring a textile manufacturer.
c) Concentric Mergers
Concentric mergers occur in industry where the companies may be supplying complementary products to customers. For example a laptop manufacturer may acquire a computer peripheral company so that it can bundle the products and offer the customer
d) Conglomerate Merger
When two companies in different industries combine they form part of conglomerate merger. This is a way of diversification for companies which may see seasonality in on of its companies and would like to spread its risks.
3) a)
STC's cost of capital = WACC= kd* Wd*(1-t) + ke* We + Kp * Wp
where Kd = Cost of debt = 8%, Wd = 0.45
Ke = D1/P0 + g = 1.5/20 + 5% = 12.5%, We = 0.5
Kp =2.5/25 = 10%, Wp = 0.05
WACC = 8%*0.45*(1-35%)+ 12.5%* 0.5 + 10%* 0.05 = 9.09%
b)
WACC = 8% * 0.3*0.65 + 12.5%* 0.65 + 10% * 0.05 = 10.185%
4)
Determinants of Option Value
There are mainly seven factors that determine an option value, they are
Current Stock Price- Price that the stock is trading currently
Strike Price - Exercise price at which the owner has the option of buying or selling a stock
Type of Option- Whether the option is a call option or put option
Days until Expiry- Number of days till expiry of option
Risk free interest rates- When the rates rise the value of option will rise and vice versa
Dividends - Dividends affect the option value such that when dividends increases calls will be worth less and put will be worth more
Volatility - Measure of daily difference in stock prices.
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