FIN2101 BUSINESS FINANCE II
MODULE 5 - TAKEOVERS
QUESTION 1
Luxe Foods is contemplating the acquisition of Valley Canning Company for a cash price of $180 000,Luxe currently has high financial leverage and therefore has a cost of capital of 15%,As a result of acquiring Valley Canning,which is financed entirely with equity,the firm expects its financial leverage to be reduced and its cost of capital therefore to drop to 10%,The acquisition of Valley Canning is expected to increase Luxe's cash inflows by $20 000 per year for the first 3 years and by $30 000 per year for the following 12 years.
a) Determine whether the proposed cash acquisition is desirable.
b) If the firm's financial leverage would actually remain unchanged as a result of the proposed acquisition,would this alter your recommendation? Support your answer with numerical data.
QUESTION 2
Firm A is planning to acquire Firm B for $140 million cash,The values of the two companies as separate entities are $200 million and $100 million respectively,Firm A estimates that by combining the two companies it will increase operating cash flows by $5 million annually in perpetuity,If the relevant cost of capital is 20%,what is the NPV of the merger to Firm A's shareholders?
QUESTION 3
Crocodile Ltd is considering the acquisition of Shark Finance,The values of the two companies as separate entities are $10 million and $5 million respectively,Crocodile estimates that by combining the two companies it will reduce its annual selling and administrative costs by $250 000 in perpetuity,Crocodile can either pay $7 million cash for Shark or offer Shark a 50% holding in Crocodile,If the opportunity cost of capital is 10% per annum:
What is the gain,in present value terms,from the merger?
What is the net cost of the cash offer?
What is the net cost of the share alternative?
What is the NPV of the acquisition under the cash offer?
What is the NPV of the acquisition under the share offer?
QUESTION 4
Fly-By-Night Couriers is analysing the possible acquisition of Flash-in-the-Pan Restaurants,Neither firm has debt,The forecasts of Fly-By-Night show that the purchase would increase its annual after-tax cash flow by $600 000 indefinitely,The current market value of Flash-in-the-Pan is $20 million,The current market value of Fly-By-Night is $35 million,The appropriate discount rate for the incremental cash flows is 8%.
a) What is the gain from the takeover?
b) What is the value of Flash-in-the-Pan to Fly-By-Night?
Fly-By-Night is trying to decide whether it should offer 25% of its stock or $15 million in cash to Flash-in-the-Pan.
c) What is the net cost of each alternative?
d) What is the NPV of each alternative?
e) Which alternative should Fly-By-Night choose?
FIN2101 BUSINESS FINANCE II
SOLUTIONS TO TUTORIAL QUESTIONS
MODULE 5 - TAKEOVERS
QUESTION 1
(a)
Conclusion
NPV ( 0,therefore proceed with the proposed acquisition.
(b)
Conclusion
NPV < 0,therefore do not proceed with the takeover.
QUESTION 2
Gain = Present value of incremental cash flows
= $5 000 000 ÷ 0.20
= $25 000 000
Net cost = Cash paid - PVB
= $140 000 000 - $100 000 000
= $40 000 000
NPV = Gain - Net cost
= $25 000 000 - $40 000 000
= -$15 000 000
ALTERNATIVE APPROACH
PVA+B = PVA + PVB + Gain
= $200 000 000 + $100 000 000 + $25 000 000
= $325 000 000
Maximum Price = PVA+B - PVA
(If NPV = 0) = $325 000 000 - $200 000 000
= $125 000 000
The value of Firm A will increase by $125 000 000 as a result of the takeover,If we pay $140 000 000,the deal has a negative NPV of $15 000 000.
QUESTION 3
(a) Gain = Present value of the savings
= $250 000 ÷ 0.10
= $2 500 000
(b) Net cost = Cash paid - PVShark
= $7 000 000 - $5 000 000
= $2 000 000
(c) Net cost = x.PVC+S - PVShark Where x = 50%
PVS = $5m
PVC+S = PVC + PVS + Gain
= $10 000 000 + $5 000 000 + $2 500 000
= $17 500 000
( Net cost = (0.5 × $17 500 000) - $5 000 000
= $8 750 000 - $5 000 000
= $3 750 000
(d) NPV = Gain - Net cost
= $2 500 000 - $2 000 000
= $500 000
(e) NPV = Gain - Net cost
= $2 500 000 - $3 750 000
= -$1 250 000
QUESTION 4
(a) Gain = Present value of incremental cash flows
= $600 000 ÷ 0.08
= $7 500 000
(b) PVT(A) = Gain + PVT
= $7 500 000 + $20 000 000
= $27 500 000
(c) Cash Alternative
Net cost = Cash Paid - PVT
= $15 000 000 - $20 000 000
= -$5 000 000
Share Alternative
Net cost = x.PVA+T - PVT Where x = 25%
PVT = $20m
PVA+T = PVA + PVT + Gain
= $35 000 000 + $20 000 000 + $7 500 000
= $62 500 000
( Net cost = (0.25 × $62 500 000) - $20 000 000
= $15 625 000 - $20 000 000
= -$4 375 000
(d) NPV = Gain - Net cost
NPVCASH = $7 500 000 - (-$5 000 000)
= $12 500 000
NPVSHARES = $7 500 000 - (-$4 375 000)
= $11 875 000
(e) Choose the CASH alternative which has the higher NPV.
MODULE 5 - TAKEOVERS
QUESTION 1
Luxe Foods is contemplating the acquisition of Valley Canning Company for a cash price of $180 000,Luxe currently has high financial leverage and therefore has a cost of capital of 15%,As a result of acquiring Valley Canning,which is financed entirely with equity,the firm expects its financial leverage to be reduced and its cost of capital therefore to drop to 10%,The acquisition of Valley Canning is expected to increase Luxe's cash inflows by $20 000 per year for the first 3 years and by $30 000 per year for the following 12 years.
a) Determine whether the proposed cash acquisition is desirable.
b) If the firm's financial leverage would actually remain unchanged as a result of the proposed acquisition,would this alter your recommendation? Support your answer with numerical data.
QUESTION 2
Firm A is planning to acquire Firm B for $140 million cash,The values of the two companies as separate entities are $200 million and $100 million respectively,Firm A estimates that by combining the two companies it will increase operating cash flows by $5 million annually in perpetuity,If the relevant cost of capital is 20%,what is the NPV of the merger to Firm A's shareholders?
QUESTION 3
Crocodile Ltd is considering the acquisition of Shark Finance,The values of the two companies as separate entities are $10 million and $5 million respectively,Crocodile estimates that by combining the two companies it will reduce its annual selling and administrative costs by $250 000 in perpetuity,Crocodile can either pay $7 million cash for Shark or offer Shark a 50% holding in Crocodile,If the opportunity cost of capital is 10% per annum:
What is the gain,in present value terms,from the merger?
What is the net cost of the cash offer?
What is the net cost of the share alternative?
What is the NPV of the acquisition under the cash offer?
What is the NPV of the acquisition under the share offer?
QUESTION 4
Fly-By-Night Couriers is analysing the possible acquisition of Flash-in-the-Pan Restaurants,Neither firm has debt,The forecasts of Fly-By-Night show that the purchase would increase its annual after-tax cash flow by $600 000 indefinitely,The current market value of Flash-in-the-Pan is $20 million,The current market value of Fly-By-Night is $35 million,The appropriate discount rate for the incremental cash flows is 8%.
a) What is the gain from the takeover?
b) What is the value of Flash-in-the-Pan to Fly-By-Night?
Fly-By-Night is trying to decide whether it should offer 25% of its stock or $15 million in cash to Flash-in-the-Pan.
c) What is the net cost of each alternative?
d) What is the NPV of each alternative?
e) Which alternative should Fly-By-Night choose?
FIN2101 BUSINESS FINANCE II
SOLUTIONS TO TUTORIAL QUESTIONS
MODULE 5 - TAKEOVERS
QUESTION 1
(a)
Conclusion
NPV ( 0,therefore proceed with the proposed acquisition.
(b)
Conclusion
NPV < 0,therefore do not proceed with the takeover.
QUESTION 2
Gain = Present value of incremental cash flows
= $5 000 000 ÷ 0.20
= $25 000 000
Net cost = Cash paid - PVB
= $140 000 000 - $100 000 000
= $40 000 000
NPV = Gain - Net cost
= $25 000 000 - $40 000 000
= -$15 000 000
ALTERNATIVE APPROACH
PVA+B = PVA + PVB + Gain
= $200 000 000 + $100 000 000 + $25 000 000
= $325 000 000
Maximum Price = PVA+B - PVA
(If NPV = 0) = $325 000 000 - $200 000 000
= $125 000 000
The value of Firm A will increase by $125 000 000 as a result of the takeover,If we pay $140 000 000,the deal has a negative NPV of $15 000 000.
QUESTION 3
(a) Gain = Present value of the savings
= $250 000 ÷ 0.10
= $2 500 000
(b) Net cost = Cash paid - PVShark
= $7 000 000 - $5 000 000
= $2 000 000
(c) Net cost = x.PVC+S - PVShark Where x = 50%
PVS = $5m
PVC+S = PVC + PVS + Gain
= $10 000 000 + $5 000 000 + $2 500 000
= $17 500 000
( Net cost = (0.5 × $17 500 000) - $5 000 000
= $8 750 000 - $5 000 000
= $3 750 000
(d) NPV = Gain - Net cost
= $2 500 000 - $2 000 000
= $500 000
(e) NPV = Gain - Net cost
= $2 500 000 - $3 750 000
= -$1 250 000
QUESTION 4
(a) Gain = Present value of incremental cash flows
= $600 000 ÷ 0.08
= $7 500 000
(b) PVT(A) = Gain + PVT
= $7 500 000 + $20 000 000
= $27 500 000
(c) Cash Alternative
Net cost = Cash Paid - PVT
= $15 000 000 - $20 000 000
= -$5 000 000
Share Alternative
Net cost = x.PVA+T - PVT Where x = 25%
PVT = $20m
PVA+T = PVA + PVT + Gain
= $35 000 000 + $20 000 000 + $7 500 000
= $62 500 000
( Net cost = (0.25 × $62 500 000) - $20 000 000
= $15 625 000 - $20 000 000
= -$4 375 000
(d) NPV = Gain - Net cost
NPVCASH = $7 500 000 - (-$5 000 000)
= $12 500 000
NPVSHARES = $7 500 000 - (-$4 375 000)
= $11 875 000
(e) Choose the CASH alternative which has the higher NPV.
