TOPIC: MERGERS AND TAKEOVER

PRACTICE QUESTIONS

Kinetic Corporation is considering acquiring High Tech Systems. Jim Smith, the vice president of finance at
Kinetic, has been assigned the task of estimating a fair acquisition price for High Tech. Smith is aware of several
approaches that could be used for this purpose. He plans to estimate the acquisition price based on each of
these approaches, and has collected or estimated the necessary financial data.
High Tech has 10 million shares of common stock outstanding and no debt. Smith has estimated that the post-
merger free cash flows from High Tech, in millions of dollars, would be 15, 17, 20, and 23 at the end of the
following four years. After Year 4, he projects the free cash flow to grow at a constant rate of 6.5 percent a
year. He determines that the appropriate rate for discounting these estimated cash flows is 11 percent. He also
estimates that after four years High Tech would be worth 23 times its free cash flow at the end of the fourth
year.

Smith has determined that three companies—Alpha, Neutron, and Techno —are comparable to High Tech. He
has also identified three recent takeover transactions— Quadrant, ProTech, and Automator—that are similar to
the takeover of High Tech under consideration. He believes that price- to- earnings, price- to- sales, and price-
to- book value per share of these companies could be used to estimate the value of High Tech. The relevant
data for the three comparable companies and for High Tech are as follows:

The relevant data for the three recently acquired companies are given below:

While discussing his analysis with a colleague, Smith makes two comments. Smith’s first comment is: “If there
were a pre- announcement run- up in Quadrant’s price because of speculation, the takeover premium should
be computed based on the price prior to the run- up.” His second comment is: “Because the comparable
transaction approach is based on the acquisition price, the takeover premium is implicitly recognized in this
approach.”
7. What is the present value per share of High-Tech stock using the discounted cash flow approach if the
terminal value of High Tech is based on using the constant growth model to determine terminal value?
A $39.38. B $40.56. C $41.57.
8. What is the value per share of High-Tech stock using the discounted cash flow approach if the terminal value
of High Tech is based on using the cash flow multiple method to determine terminal value?
A $35.22. B $40.56. C $41.57.

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9. The average stock price of High Tech for the three relative valuation ratios (if it is traded at the mean of the
three valuations) is closest to:
A $35.21. B $39.38. C $40.56.
10. Taking into account the mean takeover premium on recent comparable take-overs, what would be the
estimate of the fair acquisition price of High Tech based on the comparable company approach?
A $35.22. B $40.83. C $41.29.
11. The fair acquisition price of High Tech using the comparable transaction approach is closest to:
A $35.22. B $40.86. C $41.31.
12. Are Smith’s two comments about his analysis correct?
A Both of his comments are correct.
B Both of his comments are incorrect.
C His first comment is correct, and his second comment is incorrect.

7. Spears Financial is seeking to merge with the Cyrus Capital Group, but the managers of Spears are concerned
that regulators may consider the merger an antitrust violation. The market consists of nine competitors. The
largest company has a 20% market share and the second largest company has an 18% market share. Spears
Financial and Cyrus Capital Group are the third and fourth largest competitors with a 12% and 10% market
share, respectively. The remaining five competitors each have an 8% market share. What would be the increase
in the Herfindahl-Hirschman Index (HHI) as a result of the merger and the most likely reaction by regulators to
the merger?
Increase in the HHI Probable response by regulators
A. 60 No antitrust challenge
B. 240 Potential antitrust challenge
C. 240 No antitrust challenge

Solutions

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