In May 2003, Gencorp acquired Sequa Corp.'s propulsion subsidiary ARC for $133million in cash and $11 million in transactions costs.
Table below lists selected information about ARC at the time of acquisition (‘000s):
Sales $ 300,000
Operating income (loss) $ 8,000
Total assets $ 250,000
Capital expenditures $ 20,000
Depreciation and amortization $ 25,000
Intangible Assets (process technology) $ 20,000
Over the next three years,
a. ARC sales will increase by 5% each year (with or without the merger). Part of the reason for the merger is Gencorp's expectation that ARC would achieve this growth at the expense of Gencorp's propulsion division (with or without the merger).
b. Operating income will remain as the same fraction of sales.
c. Capital spending needs to be maintained at current levels and depreciation will remain constant. But, the acquisition lowers Gencorp's capital spending, without any further loss in sales, by $5,000 a year, for the next three years. Assume that the lowered capital expenditures will have no impact on depreciation. After three years,
d. free cash flows to the firm (ARC) are expected to grow at a constant rate of 3% forever, with or without the merger. No impact on Gencorp after year 3.
The average beta for the industry is 1.5, with a market value based debt ratio of 50%. As part of the combined firm the debt ratio can be increased to 60% without any change in the pre-tax cost of debt of 7.5%. Market risk premium is 4% and risk- free rate is 5%. Marginal tax rate is 30%. Is the acquisition beneficial for Gencorp's shareholders?