Corporate Finance

Running Head : Corporate Finance

A sporting good manufacturer has decided to expand into a related business . Management estimates that to build and estimates that to build and staff a facility of the desired size and to attain capacity operations would cost 275 million in present value terms Alternatively , the company could acquire an existing firm or division with the desired capacity . One such opportunity is the division of another company . The book value of the division 's asset is 140 million and its earnings before interest and tax are presently 30 million

br Publicly traded comparable companies are selling a narrow range around 12 times current earnings . The companies have debt-to-asst ratios averaging 40 percent with an average interest rate of 10 percent

a . Using a tax rate of 34 percent , estimate the minimum price the owner of the division should consider for its sale .b . What is the maximum price the acquirer should be willing to pay ? c . Does it appear that that an acquisition is feasible ? Why or why not ? d . Would a 25 percent increase in stock prices to an industry average price to-to-earnings ratio of 15 change your answer to (c ? Why or why not ?e . Referring to the 275 million price tag on the replacement value of the division what would you predict would happen to acquisition activity when market values of companies and divisions rise above their replacement values

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The current value of the division acquisition is given by the number of divisions Assets (book values ) and the earnings after interest and tax (Eliud , 1999 (EAIT

Earnings after interest and tax are given by

Earnings before interest and tax

Less interest

Less tax Interest interest rate (r debt

Debt to asset ratio 40

Debt 40 14 ,000 ,000 .00

100 56 ,000 ,000 .00 Interest 10 56 ,000 ,000 .00 5 ,600 ,000 .00

Earnings after interest EBIT - Interest 30 ,000 ,000 .00 - 5 ,600 ,000 .00 24 ,400 ,000 .00

Tax tax rate EBT 34 24 ,400 ,000 .00 8 ,296 ,000 .00

Earnings after interest and tax

EAIT 24 ,400 ,000 .00 - 8 ,296 ,000 .00 16 ,104 ,000 .00

The minimum price the division owner should consider to sale 140 ,000 ,000 .00 16 ,104 ,000 .00 156 ,104 ,000 .00

N .B

EBIT Earnings before interest and tax (b ) The maximum price the acquirer should be willing to pay 140 ,000 ,000 .00 (16 ,104 ,000 .00 12 333 ,248 ,000 .00 (c ) Acquisition seems infeasible only when the division owner sells at minimum

This is because the cost of purchase would be more than cost of building and staffing the facility (d ) A 25 increase in stock prices will not change the answer in (c This is because the change will lead to a maximum possible purchase price of 284 ,936 ,000 .00 , which is also higher than the cost of building , which is 275 ,000 ,000 .00 . i .e (16 ,104 ,000 12 75 284...