Penn Corp. is analyzing the possible acquisition of teller company. Both firms have no debt. Penn believes the acquisition will increase its total after tax annual cash flow by $3.1 million indefinitely. The Current market value of teller is $78 million and that of Penn is $135 million. The appropriate discounting rate for the incremental cash flows is 12%. Penn is trying to decide whether it should offer 40% of its stocks or 94 million in cash to Teller’s shareholders. A. What is the cost of each alternative B. What is the NPV of each alternative C. Which alternative should Penn choose

Step 1

Part A) The cost of each alternative can be calculated as follows :

Cash cost given = $94 million

Value of the target firm = Market value of firm + Present value of cash flows

Value of the target firm = $78 million + $3.1 million/12%

= $103.83 million

Now, the equity cost can be computed as follows :

Equity cost = 40% × (Market value of acquiring firm + Value o target firm)

Putting values above :

Equity cost = 40% × ($135 million + $103.83 million)

= $95.53 million

Step 2

The net present values can be computed as follows :

NPV value of cash/stock = Value of target firm − Cost of acquisition

Putting values above :

NPV cash = $103.83 million − $94 million = $9.83 million

NPV stock = $103.83 million − $95.53 million = $ 8.30 million

Step 3

The subject company should choose for cash option as their NPV is higher in cash option relative to the stock option.