Vision Consulting Inc. is considering making an offer to purchase Gulf Corp. The
ID: 2794879 • Letter: V
Question
Vision Consulting Inc. is considering making an offer to purchase Gulf Corp. The vice president of finance has collected the following information: Vision Inc. Gulf Corp. 12.50 1,200,000 $2,400,000 Price-earning ratio Shares outstanding Earnings 250,000 $540,000 Vision Consulting Inc. also knows that securities analysts expect the earnings and dividends (currently $0.75 per share) of Gulf Corp. to grow at a constant rate of 4 percent each year. Vision Consulting Inc. management believes that the acquisition of Gulf Corp. will provide the firm with some economies of scale that will increase this growth rate to 6 percent per year. Note: Please make sure your final answers are accurate to 2 decimal places. a) What is the value of Gulf Corp. to Vision Consulting Inc.? Value of Gulf Corp. to Vision Consulting Inc. $ b) What would Vision Consulting Inc.'s gain be from this acquisition? Gain = $ c) If Vision Consulting Inc. were to offer $14 in cash for each share of Gulf Corp., what would the NPV of the acquisition be? d) What's the most Vision Consulting Inc. should be willing to pay in cash per share for the stock of Gulf Corp.? Maximum payable price $ e) If Vision Consulting Inc. were to offer 100,000 of its shares in exchange for the outstanding stock of Gulf Corp., what would the NPV be? NPV stock = $ f Should the acquisition be attempted, and, if so, should it be as in (c) or as in (e)? O Yes, as in (e) O No Yes, as in (c)Explanation / Answer
a) First find the required return for shareholders of the target firm Gulf's EPS= Earnings/ Shares outstanding $540,000/250,000 = $2.16 Per share Price per share P0 = P/E ratio x EPS = 6 X $2.16 $12.96 Dividend Per share D0 $0.75 per share Growth rate (g) 4.00% Cost of Equity Re = D0 x (1+ g)/P0 + g = ($.75 x (1+4%)/$12.96 + 4% 10.02% Price per share of Gulf with the new growth rate New growth rate 6.00% New Price = D0 x (1+g)/(Re - g) = ($.75 x (1+6%)/(10.02%-6%) $19.78 Value of Gulf Corp. to Vision consulting Inc. = Shares outstanding/ New price = 250,000 shares /$19.78 $4,945,852.53 b) Gain = $4,945,852.53 - (250,000 shares x $12.96) $1,705,852.53 c) NPV of the acquisition = $4,945,852.53 - (250,000 shares x $14) $1,445,852.53 d) Maximum bid price = $14 + ($1445852.53/250,000 shares) $19.78 e) Vision's EPS= Earnings/ Shares outstanding $2,400,000/1,200,000 = $2.00 Per share Price per share P0 = P/E ratio x EPS = 12.50 X $2 $25.00 Market value of Vision 's shares = $25 x 1200000Shares $30,000,000.00 Price of the stock in the merged firm = $30,000,000+$4,945852.53)/(1200000+100000) $26.88 NPV of the acquisition = $4,945,852.53 - (100,000 shares x $26.88) $2,257,710.03 f) Yes, as in e NPV is higher.
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