ABC Inc is a firm with two large divisions operating in the aerospace and fast food industries.The
Question:
ABC Inc is a firm with two large divisions operating in the aerospace and fast food industries.The current CEO has defended such diversification as a move to lower its cost of debt capital since cash flow from each division tends to offset the other division's shortfalls.This makes ABC's debt less risky than a pure-play firm's debt.Unfortunately, the current CEO is about to retire, and in her place is coming a new CEO who believes that spinning off the fast food division will bring about a more focused firm and add value for shareholders.The new CEO believes that the common stock of the fast food spunoff unit will trade at a P-E multiple of 15, while the remaining aerospace shares will continue to trade at a multiple of 10.The current P-E multiple for the firm is 10.
Assuming that the two units currently contribute equal earnings to the firm, calculate the percent gain in equity value from the spinoff.
Equity Asset Valuation
ISBN: 978-0470571439
2nd Edition
Authors: Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, John D. Stowe, Abby Cohen