Plant Inc. is considering making an offer to purchase Palmer Corp. Plant’s VP ha
ID: 2750435 • Letter: P
Question
Plant Inc. is considering making an offer to purchase Palmer Corp. Plant’s VP has collected the following information:
Plant
Palmer
Price-earnings Ratio
14.00
11.0
Shares Outstanding
1,000,000
620,000
Earnings
$1,800,000
$580,000
Dividends (total)
$600,000
$290,000
Plant also knows that analysts expect the earnings and dividends of palmer to grow at a constant rate of 5% each year. Plant’s management believes that the acquisition of Palmer will provide their firm with some economies of scale that will increase this growth rate further to 7% per year.
1. If Plant were to offer $17 in cash for each share of Palmer, what would the NPV of the acquisition be?
2. What should be the maximum price per share (in cash) that Plant should be willing to pay for Palmer’s shares?
Plant
Palmer
Price-earnings Ratio
14.00
11.0
Shares Outstanding
1,000,000
620,000
Earnings
$1,800,000
$580,000
Dividends (total)
$600,000
$290,000
Explanation / Answer
1. Consideration to be paid to palmer = 17x620000
= 10540000
Increase in earnings of palmer = 580000 x 105%
= 609000
Ke of palmer = 1/11 = 0.0909
Value of palmer = 609000/0.0909 - 0.05
= 14889975
Increase in earnings of plant = 1800000x7% = 126000
Ke of plant = 1/14 = 0.0714
Value of plant = 126000/0/0714 = 1764706
NPV from acquisition = 14889975+1764706-10540000
= 6114681
(b) Benefit from acquisition of palmer = 14889975 + 1764706 = 16654681
Maximum price per share = 16654681/620000
= $28.86 per share