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 $3.7 million indefinitely.The current market value of Teller is $103 million,and that of Penn is $151.7 million.The appropriate discount rate for the incremental cash flows is 9 percent.Penn is trying to decide whether it should offer 40 percent of its stock of $127 million in cash to Teller's shareholders.The cost of the cash alternative is _____,while the cost of the stock alternative is _____.
A)$103,000,000; $118,324,444
B)$103,000,000; $127,000,000
C)$127,000,000; $103,000,000
D)$127,000,000; $118,324,444
E)$236,000,000; $103,000,000

Question

Quizplus · Accepted Answer

Cash cost = Amount of cash offered = $127 millionTo calculate the cost of the stock offer, we first need to calculate the value of the target to the acquirer. The value of the target firm to the acquiring firm will be the market value of the target plus the PV of the incremental cash flows generated by the target firm. The cash flows are a perpetuity, so:V* = $103,000,000 + $3,700,000/0.09 = $144,111,111The cost of the stock offer is the percentage of the acquiring firm given up times the sum of the market value of the acquiring firm and the value of the target firm to the acquiring firm. So, the equity cost will be:Equity cost = 0.4($151,700,000 + $144,111,111) = $118,324,444

Penn CorpIs Analyzing the Possible Acquisition of Teller Company