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Expected Gain from Acquisition

Hampshire-Cathaway (H-C), a large established corporation with no growth in its real earnings, is considering acquiring 100% of the shares of Trilennium Corporation, a young firm with a high growth rate of earnings. The acquisitions analysis group at H-C has produced the following table of relevant data:

Hampshire-Cathaway Trilennium
Earnings per share $3.00 $2.00
Dividend per share $3.00 $0.80
Number of shares 200 million 10 million
Stock price $30 $20

H-C's analysts estimate that investors currently expect growth of about 6% per year in Trilennium's earnings and dividends. They assume that with the improvements in management that H-C could bring to Trilennium, its growth rate would be 10% per year with no additional investment outlays beyond those already expected.

a. What is the expected gain from the acquisition?
b. What is the NPV of the acquisition to H-C shareholders if it costs an average of $30 per share to acquire all of the outstanding shares?
c. Would it matter to H-C's shareholders whether the shares of Trilennium stock are acquired by paying cash or H-C stock?

Solution Preview

a) First calculate the required rate of return on Trilennium r=D1/P0+g=0.80*(1+6%)/20+6%=10.24%
Now calculate the value of stock assuming the growth rate of 10% per annum = D0*(1+g)/(r-g)
=0.80*(1+10%)/(10.24%-10%)=$366.67
Expected gains from the acquisition = ($366.67-$20)*10 ...

Solution Summary

The expected gain from acquisition is determined. The NPV of the acquisition to H-C shareholders if it costs an average of $30 per share to acquire all of the outstanding shares is determined.

$2.19