- Use the data contained in Table 1 to construct Chic’s cash flows for 2014 through 2017. Why interest expense is typically deducted in merger cash flows, whereas it is not normally deducted in capital budgeting cash flow analysis? Why are retentions deducted in the cash flow analysis?
- Conceptually, what is the appropriate discount rate to apply to the cash flows developed in Question 1? What is the numerical value? How much confidence can one place in this estimate; that is, is the estimated discount rate likely to be in error by a small amount such as 1 percentage point or a large amount such as 4 or 5 percentage points?
- What is the terminal value of Chic: that is, what is the 2017 value of the cash flows Chic is expected to generate beyond 2017? What is Chic’s value to Nina’s at the beginning of 2014? Suppose another firm was evaluating Chic as a potential acquisition candidate. Would they obtain the same value? Explain.
- a. Suppose Chic’s management has a substantial ownership interest in the company, but not enough to block a merger. If Chic’s managers want to keep the firm independent, what are some actions they could take to discourage potential suitors?
b. If Chic’s managers conclude that they cannot remain independent, what are some actions they might take to help their stockholders (and themselves) get the maximum price for their stock?
c. If Chic’s managers conclude that maximum price they can get anyone to bid for the company is less than its “true value”, is there any other action they might take that would benefit both outside stockholders and the managers themselves? Explain.
d. Do Chic’s managers face any potential conflicts of interest in any of the situation presented in a through c? Explain and suggest what might be done to reduce the damage from conflicts of interest.
- Chic has 5 million shares of common stock outstanding. The shares are traded infrequently and in small blocks, but the last trade, of 500 shares, was at a price of $1.50 per share. Based on this information and on your answers to Questions 3 and 4, how much should Nina’s offer, per share, for Chic, and how should it go about making the offer?
- Do you agree that synergistic effects create value in the average merger? If so, how is this value generally shared between the stockholders of the acquiring and acquired companies; that is, does more of the value go to the acquired or to the acquiring firm? Explain.
- A major concern in the analysis is the accuracy of the cash flow growth rate- how would the maximum price vary if this rate were greater or less than the expected 5 percent? Using Excel, perform a sensitivity analysis designed to determine the importance of the growth rate and determine the minimum growth rate that would justify a price of $2 per share.
- Another major concern is the discount rate used in the analysis. What would Chic’s value to Nina’s be if Chic’s beta were higher or lower than the 1.2 originally estimated or if the market risk premium were above or below the estimated 6 percent? Discuss the effects of these factors on the acquisition and on how much Nina’s should offer. Quantify your results using Excel.
- Would the response of Chic’s stockholders be affected by whether the offer was for cash or for stock in Nina’s? Explain.
- What are your final conclusions regarding how much Nina’s should offer and the form of the offer?
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