Question

Question 2 (50 marks) Owen Corporation considers acquiring Harry Computers. The financial data of the two firms are as follows. Harry Computers Owen Corporation $2.5 450,000 Earnings per share Number of outstanding shares P/E ratio Current dividend per share $2.0 150,000 10 $0.8 12 $1.0 The financial analyst expects Harry Computers' dividends to grow at a rate of 5% per year. Owen Corporation believes that the synergy from the acquisition will improve the growth to 6% per year. Required: a Assume that Owen Corporation negotiates a stock-for-stock acquisition on the basis of price per share. If Owen Corporation pays the minimum price to Harry Computers, please analyse how many shares of Owen Corporation common stock are outstanding after the acquisition. (12 marks)

Answer 1

Information provided by the Question is as follows -

2 3 EPS 4 Number of Shares Outstanding 5 PE Ratio 6 Current Dividend Per Share Harry Computers Owen Corporation 2.00 2.50 1,50,000 4,50,000 10.00 12.00 0.80 1.00 7 8 Harry's Dividend Growth Rate 9 After Synergy Expected Dividend 10

Part A :

Minimum price Owen Corp can pay is the current share price of Harry Computers.
Harry Computer Current Market Price(CMP) = PE Ratio * EPS
= 10*2
= 20
Total Market Value of Harry Computers = Number of shares outstanding * CMP
= 150000*20
= 3,000,000

Owen Corp CMP = PE Ratio * EPS
= 12 * 2.5
= 30

Total Number of shares to be issued to Share Holders of Harry Computers
= Total Market Value of Harry Computers/Owen Corp CMP
= 3,000,000/30
= 100,000

Total Shares Outstanding After Acquisition
  = Owen Corp's Shares Outstanding before acquisition + issued to shareholders of Harry's Computers
= 450,000 + 100,000
= 550,000

Common Calculation for next parts :

NPV of acquisition is 1 Share of Owen is offered for 1 share of Harry's

Remember as per Dividend Distribution Model
P = D1/(r-g) = D0*(1+g)/(r-g)

P = Price of Stock
D1 = DIvidend after 1 year
r = discount rate
g = dividend growth rate
D0 = Dividend paid in current year

For current pricing of Harry's stock
P = 20
D1 = D0*(1+g) = 0.8*(1+5%) = 0.84
20 = 0.84/(r-5%)
r-5% = 0.84/20 = 4.20%
r = 5% + 4.20% = 9.2%

If after acquisition g = 6%
P = 0.84/(9.20%-6%) = 0.84/3.2% = 26.25

Part B :

NPV of acquisition is 1 Share of Owen is offered for 1 share of Harry's

Cost of Acquisition = Share Price of Owen * No. of shares of Harry
= 30 * 150,000
= 4,500,000

Value of Harry's after acquisition = Price of Harry's Share at 6% growth * No. of shares of Harry's
= 26.25*150,000
= 3,937,500

NPV of this acquisition = Value of acquired asset - cost of asset
= 3,937,500 - 4,500,000
= -562,500

Owen should not go for this acquisition as NPV is negative.

Part C:

If Owen pays 25 per share for Harry;s

Cost of Acquisition = Share Price of Owen * No. of shares of Harry
= 25 * 150,000
= 3,750,000

Value of Harry's after acquisition = Price of Harry's Share at 6% growth * No. of shares of Harry's
= 26.25*150,000
= 3,937,500

NPV of this acquisition = Value of acquired asset - cost of asset
= 3,937,500 - 3,750,000
= 187,500

Owen should go for this acquisition as NPV is Positive.

Part D:

Max Cash price that can be paid is = Fair value of Harry's Share after acquisition
= 26.25

In terms of shares of Owen Corp -
Value of Harry's = 3,937,500

No. of shares of Owen to be issues = Value of Harry's after acquisition/Share price of Owen
= 3,937,500/30
= 131,250

so, for 150,000 shares of Harry's, 131,250 shares of Owen are to be issued.

Or, Number of Owen's Shares received for 1 share of Harry's = 131,250/150,000 = 0.875

Ans : Owen can pay $26.25 for 1 share of Harry;s
Or Harry's 1 share is equivalent to 0.875 shares of Owen.