Question 1: Mergecandor Corp. is considering the acquisition of Tenderlon Inc. Mergecandor has two million shares outstanding selling at $30, or 7.5 times its earnings per share, and Tenderlon has one million shares outstanding selling at $15, or five time its earnings per share. Mergecandor would offer to exchange two shares of tenderloin for one share of Mergecandor.
a) If there would be no wealth created from the merger, what would be the earnings per share of the merged firm?
Its price-to-earnings ratio (P/E ratio)?
Its share price?
Would there be any wealth transfer between the shareholders of the two companies?
b) Suppose that, after the merger, the market would not adjust the P/E ratio of Mergecandor, which will stay at 7.5. What would be any wealth transfer between the shareholders of the two companies?
Question 2: Murlow Company is a privately held firm, David Murlow, its owner-manager, has been approached by Murson Inc. for possible acquisition. The firm has no debt. What is the price David Murlow should ask, given the following information about the firm?
• Sales, currently at $500 million, are expected to grow by 6 percent for the next three years, and then by 4 percent in perpetuity.
• The operating margin before tax is expected to remain at 20 percent of sales.
• Annual capital expenditures are expected to be equal to the depreciation expense of the year.
• The working capital requirement would remain at 18 percent of sales.
• The corporate tax rate is 40 percent.
• David Murlow requires a return of at least 10 percent of his family investment in the firm.
Question 3: The Brankton Company, an American firm, considers investing in Spain. The investment will cost EUR125 (€125) million and is expected to generate, after taxes, €30 million a year during the next five years in real terms, that is, before inflation. The project would be liquidated at the end of the fifth year and its terminal value is estimated at €30 million. The annual rate of inflation is expected to be 3 percent in the Euroland and 4 percent in the United States. The cost of capital used in Brankton for its investment in the Euroland is 7 percent above the yield on government bonds. Currently, the rate on U.S. government bonds is 5 percent and the exchange rate is EUR/USD0.80. Calculate the net present value of the project in U.S. dollars.