You were hired on January 1, 2005, by firm Y. Firm Y was going to make
an offer for Firm X that week, and your first task was to determine
the maximum price htat should be paid for each common share of Firm X.
You were given the following information.
1. Firm X is in a different industry than Firm Y
2. Firm X Balance sheet 12/31/04(thousand)
Cash $100 Long-term debt $500
Acc.receivable 250
Inventory 500
Net fixed assets 1,650 Net worth 2,000
Total $2,500 Total $2,500
After the transaction, Firm Y would own all the assets and assume
responsibility for the long term-debt.
3. Net sales for Firm X for the year ended December 31, 2004, were $2 million.
4. Firm Y's investigation revealed that there were no excess assets
and taht all current asset levels would change in direct proportion to
sales. FE, if sales increased by 5%, cash, a/r, and inventory would
each increase by 5%.
5. Because of the nature of Firm X's business, current liabilities
were zero and would remain at that level in the future.
6. Firm X's beta at December 31, 2004, was 1.8 and this figure assumed
that the debt to capital ratio at 12/31/2004 would be maintained in
the future. The interest rate on Firm X's long-term debt was 12%. An
annual interest payment of $60,000 was made on 12/31/2004.
7. Firm Y's managme believed that , beciase of Firm X's business, it
should have no debt in its capital structure. Thus, immediately after
the transaction, the $500,000 would be retired (there would be no
prepayment penalty and you may ignore the interest taht would be due
for the first few days of 2005. In other words, the total cash outlay
required to retire the debt would be $500,000)
8. Firm X had 1 million shares of common stock outstanding at
12/31/2004, and the price per share on that date was $2. The market
value of its debt at 12/31/2004 was $500,000.
9. The following estimates of sales and EBIT for firm X:
Annual sales Annual EBIT
Y-1 $2.2 million $400,000
Years 2 & 3 2.5 million 440,000
Years 4 & 5 2.7 million 460,000
Years 6-10 2.8 million 480,000
In arriving at the EBIT estimates depreciation expense of $100,000 per
year was deducted for years 1-3, and depreciation expense, and
depreciation expense of $140,000 per year was deducted for years 4-10.
10. Expenditures on fixed assets would be necessary to replace
worn-out equipment and to provide the new capacity needed for growth.
No expenditures would be required for year 1. Expenditures in years
2-4 would be $200,000 per year. For years 5-9, ifxed asset
expenditures would be $50,000 per year, and there would be no fixed
asset expenditures in year 10.
11. The terminal value of Firm X at the end of the ten years would be
$2.3 million (ignore the potential tax impact of the sale of Firm X in
ten years)
12. The income tax rate of Firm X and Firm Y was 50%, and that rate
was expected for each of the next ten years.
13. Firm Y's cost of equity was 18%, and its weighted average cost of
capital was 12%.
Compute the maximum price that Firm Y whould pay for each of Firm X's
shares. You may assume the risk-free rate is 8% and the required
return for the market is 13%. |
