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 $2 million indefinitely. The current market value of Teller is $54 million, and that of Penn is $84 million. The appropriate discount rate for the incremental cash flows is 10 percent. Penn is trying to decide whether it should offer 45 percent of its stock or $72 million in cash to Teller's shareholders.

What is the cost of each alternative? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

What is the NPV of each alternative? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Which alternative should Penn choose?

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 $2 million indefinitely. The current market value of Teller is $54 million, and that of Penn is $84 million. The appropriate discount rate for the incremental cash flows is 10 percent. Penn is trying to decide whether it should offer 45 percent of its stock or $72 million in cash to Teller's shareholders.

Explanation / Answer

Part 1)

The stock of each alternative is calculated as below:

Cash Cost = Cash Offered = $72 million or $72,000,000

Equity Cost = Percentage of Stock Offered*[Current Market Value of Pen + (Current Market Value + Incremental After-Tax Cash Flow/Discount Rate)] = 45%*(84,000,000 + 54,000,000 + 2,000,000/10%) = $71,100,000

______

Tabular Representation:

______

Part 2)

The NPV of each alternative is determined as follows:

NPV Cash = Value of Target Firm - Cash Cost = (54,000,000 + 2,000,000/10%) - 72,000,000 = $2,000,000

NPV Stock = Value of Target Firm - Equity Cost = (54,000,000 + 2,000,000/10%) - 71,100,000 = $2,900,000

______

Tabular Representation:

______

Part 3)

Penn should choose Stock Option as it results in higher NPV for the company.

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