Suppose Firm E wants to acquire Firm F. Firm F exists only for three years after which
Question:
Suppose Firm E wants to acquire Firm F. Firm F exists only for three years after which it is liquidated. The liquidation value is zero. As a stand-alone firm, Firm F is expected to have sales of (in $million) 160 in year 1, 180 in year 2, and 200 in year 3. Its COGS and SGAE together are expected to be 80% of sales. Firm F's depreciation (not included in COGS or SGAE) is forecast to be $10 million for each of the three years. Its capital expenditures are forecast to be equal to depreciation and there is no increase in net working capital and no increase in net other assets forecast for Firm F. The marginal corporate tax rate is 20%. Firm E's WACC is 7% and Firm F's WACC is 9%. Firm E estimates that it can reduce Firm F's costs such that COGS and SGAE together in every year will be only 75% of sales, but the acquisition will not affect the forecast for Firm F in any other way. You can assume that it is appropriate to discount year 1's expected free cash flow with a full annual discount rate
(a) Suppose Firm E finances the acquisition of Firm F with cash. What is the maximal price Firm E can pay for Firm F without overpaying (so that the NPV of the acquisition is zero)? Show your calculations
b) Now suppose that Firm E pays for the acquisition with stock by exchanging each share of Firm F into a certain number of shares of Firm E. Could financing the acquisition with stock in this way make a difference for the ability of Firm E's shareholders to gain from the acquisition when compared to financing the acquisition with cash, as in (a)? Why or why not? Explain your reasoning carefully. No calculations are needed here