Corporate Finance for E&BE (EBB079A05)

Tutorial exercise 6 (course week 8)

Merger and Acquisition Train (MAT) considers to acquire Slow Growth Industries
(SGI). As background for the possible offer the financial manager of MAT, Mrs.
Penny-Wise, has collected the following information, see table 1.

Table 1 Relevant information concerning the possible purchase of SGI

MAT SGI
Actual price- 15 10
earnings ratio
Number of shares 200 million 50 million
Actual earnings € 300 million € 90 million

Mrs. Penny-Wise knows that security analysts expect the earnings and dividends (at
the moment both € 1.80 per share) of SGI to stay constant over the coming years.
However, her research indicates that the acquisition would provide SGI with some
economies of scale that would lead to a growth rate of these dividends of 3% per
year. For calculation purposes you can assume that this expected growth will start
immediately upon the acquisition and that the rate will stay constant forever. SGI is
all-equity financed; the applicable required rate of return on the SGI shares is 10%. In
addition, you can abstract from taxes and transactions costs.

1 Calculate the actual value of SGI (assume that the financial markets are not aware of
SGI’s acquisition plans).

2 Assuming that the acquisition is going to take place, what will be the value of SGI to
MAT?

3 If MAT offers € 25 in cash for each outstanding share of SGI, what will be the Net
Present Value (NPV) of the acquisition for MAT?

4 Assuming instead that MAT offers 55 million of newly issued shares in exchange for
the outstanding stock of SGI – consequently, after the acquisition there will be
255 million MAT-shares outstanding – what will be the NPV of the acquisition for
MAT?