Problem 28-9 on Acquisition Analysis based on Chapter 28
Mergers and Acquisitions
(Excel file included) Your company has earnings per share of $4. It has 1 million
shares outstanding, each of which has a price of $40. You are
thinking of buying TargetCo, which has earnings per share of $2, 1
million shares outstanding, and a price per share of $25. You will
pay for TargetCo by issuing new shares. There are no expected
synergies from the transaction. a. If you pay no premium to buy TargetCo, what will your
earnings per share be after the merger? b. Suppose you offer an exchange ratio such that, at current
preannouncement share prices for both firms, the offer represents a
20% premium to buy TargetCo. What will your earnings per share be
after the merger? c. What explains the change in earnings per share in part (a)?
Are your shareholders any better or worse off? d. What will your price-earnings ratio be after the merger (if
you pay no premium)? How does this compare to your P/E ratio before
the merger? How does this compare to TargetCos premerger P/E
ratio?
Problem 16-8 on Managerial Decision based on Chapter 16
Financial Distress, Managerial Incentives, and
Information (Excel file included) As in Problem 1, Gladstone Corporation is about to launch a new
product. Depending on the success of the new product, Gladstone may
have one of four values next year: $150 million, $135 million, $95
million, or $80 million. These outcomes are all equally likely, and
this risk is diversifiable. Suppose the risk-free interest rate is
5% and that, in the event of default, 25% of the value of
Gladstones assets will be lost to bankruptcy costs. (Ignore all
other market imperfections, such as taxes.) a. What is the initial value of Gladstones equity without
leverage? Now suppose Gladstone has zero-coupon debt with a $100 million
face value due next year. b. What is the initial value of Gladstones debt? c. What is the yield-to-maturity of the debt? What is its
expected return? d. What is the initial value of Gladstones equity? What is
Gladstones total value with leverage? Suppose Gladstone has 10 million shares outstanding and no debt
at the start of the year. e. If Gladstone does not issue debt, what is its share
price? f. If Gladstone issues debt of $100 million due next year and
uses the proceeds to repurchase shares, what will its share price
be? Why does your answer differ from that in part (e)?
Problem 16-9 on Financial Distress based on Chapter 16
Financial Distress, Managerial Incentives, and
Information Kohwe Corporation plans to issue equity to raise $50 million to
finance a new investment. After making the investment, Kohwe
expects to earn free cash flows of $10 million each year. Kohwe
currently has 5 million shares outstanding, and it has no other
assets or opportunities. Suppose the appropriate discount rate for Kohwes future free
cash flows is 8%, and the only capital market imperfections are
corporate taxes and financial distress costs. a. What is the NPV of Kohwes investment? b. What is Kohwes share price today? Suppose Kohwe borrows the $50 million instead. The firm will pay
interest only on this loan each year, and it will maintain an
outstanding balance of $50 million on the loan. Suppose that
Kohwes corporate tax rate is 40%, and expected free cash flows are
still $10 million each year. c. What is Kohwes share price today if the investment is
financed with debt? Now suppose that with leverage, Kohwes expected free cash flows
will decline to $9 million per year due to reduced sales and other
financial distress costs. Assume that the appropriate discount rate
for Kohwes future free cash flows is still 8%. d. What is Kohwes share price today given the financial
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