$1.$Proforma Income Statement: $19891990199119921993199419951996$

Revenues $($in millions$)9009609879701,0101,0151,0151,030$

Cost of Sales $603643661650677680680690$

Operating Expenses $243259266262273274274278$

Income $5458595861616162$

$*$ After $1996,$ Cardinal should earn approximately $$55$ million per year $($on average$).$

Proforma Cash flow Statement: $19891990199119921993199419951996$

Income $5458595861616162$

Depreciation $2024262830334545$

Work Cap from Operations $748285869194106107$

Working investment $1516161617171111$

Cash flow from Operations $5966697074779596$

CCardinCardinal Inc. Fact Sheet

Birdbath industry P$/$E ratio $10$

Birdbath industry cost of capital $12\%$

Cardinal's cost of capital $12\%$

Bluejay's cost of capital $8\%$al Inc. Fact Sheet

Birdbath industry P$/$E ratio $10$

Birdbath industry cost of capital $12\%$

Cardinal's cost of capital $12\%$

Bluejay's cost of capital $8\%$apital expenditures $3940454020321836$

Residual Cash flow to BJC $2026243054457760$

$*$ From $1997$ through $2003$ we expect that cash flows will remain constant $$50$ million per year. Subsequently, we expect that cash flows will grow by $3\%$ per year. BJC will receive the residual cash at the end of each year listed.

$1.$ What cost of capital should be used to value Cardinal? Why is that rate the appropriate one?

The proper discount required when evaluating the value of Cardinal should be $12\%,$ as indicated in the information document at Hand. This is because is this a marginal cost of capital for the whole industry and it comprises the growth expectations of investors in the birdbath business. Although Bluejay bore a return of $8\%,$ it is appropriate to use $12\%$ as cost of capital of a reasonable alternative valuation because of the risk that will be seen by stakeholders in Cardinal and not diminished in Bluejay.

In this case, calculating cost of capital isn$$t necessary since it is given at $12\%,$ but that is applicable as a general form for reasoning.

$2.$ Assuming the purchase price of $$431\mathrm{.}5$ million, what is the net present value of this transaction? Should Bluejay Corp. make the acquisition?

$$ Cash flows from $1997$ to $2003$: $$50$ million per year.

$$ Growth rate of cash flows after $2003$: $3\%$ per year.

$$ Discount rate $($cost of capital$)$: $12\%.$

$$ Purchase price: $$431\mathrm{.}5$ million.

In order to determine the Net Present Value $($NPV$)$ of the deal, we need to take the future cash flows of Cardinal and calculate the present value of these cash flows at the required cost of capital which is $12\%$ and then further deducting out the costs of purchase.

Going forward, an increase in cash flows is still anticipated for the successive years; however, the growth during the years is lower at a rate of $3\%.$

In such a case, one way to approach that problem is to calculate these cash flows in$,$ year $2003$ terms using the growing formula $($PV$2003=$ CF$2004/$ r $$ g$).$

The cash flow in $2004$ after the rate of discount is applied is CF $2004,$ r $$ the rate of discount $(12\%)$ and the growth rate is g $(3\%).$

a$)$ Discount Cash Flows from $1989$ to $1996($PV $=$ CF $(1+$ r$)^$t $)$

b$)$ Discount Cash Flows from $1997$ to $2003$ This in turn means that it has cash inflow of $$50$

million annually from the year $1997$ to $2003$ and in turn the subsequent calculation is

appropriate.

c$)$ Present Value of Cash Flows from $2004$ onwards $($PV$2003=$ CF$2004/$ r $$ g$)$

d$)$ Total NPV $=$ NPV $1989-1996+$ NPV$1997-2003+$ NPV $2004$ onwards.

$$ Net present value $=$ Total NPV $$ purchase price $=$ $$487$ mil $-$ $$431\mathrm{.}5$ mil $=$ $ $55\mathrm{.}5$ mil

$$ Yes, Bluejay Corp. should proceed with the acquisition as the NPV is positive, which indicates that the transaction will create additional value for the company and its shareholders.

$3.$ Under the current scenario, if Bluejay did make the acquisition, what should happen to its own stock price?

Should Markets predict the acquisition of Cardinal by Bluejay Corp. will be successful and result in increased market share and economies of scale, Bluejays stock price is likely to increase as well. This may happen owing to the fact that, investors buy more shares expecting future earnings to increase as a result of the acquisition and therefore increasing the demand $-$ and the price of the stock.

A rise in stock price would occur in line with the acquisition value creation divided by the total outstanding shares. If the acquisition is perceived positively, any stock price is likely to go up as investors expect increased earnings in the future associated with the acquisition.

$4.$ Now, assume that once Bluejay takes control, it will close Cardinal's prefab birdhouse business. This segment has been losing money for several years. Cash losses of $$18$ million are expected to continue for seven years at which point it was expected to generate $$3$ million in cash per year, forever. $($Cardinal kept the segment for undisclosed strategic reasons.$)$

What is the net present value of acquiring Cardinal, now?