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Net Present Volume, Mergers and Acquisitions

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Part I:

Net Present Value (NPV) method is one of the most important methods used to make capital budgeting decisions by almost every company. NPV method is important because it helps financial managers maximize shareholders' wealth by making better capital budgeting decisions.

Suppose Micron Technology (NasdaqGS: MU - http://finance.yahoo.com/q?s=MU&ql=1) is considering a new project that will cost $2,425,000 (initial cash outflow). The company has provided the following cash-flow figures:

Year
Cash Flow

0
-$2,425,000

1
450,000

2
639,000

3
700,000

4
550,000

5
1,850,000

If Micron Technology's cost of capital (discount rate) is 11%, what is the project's net present value? Based on your analysis and findings, what would you recommend to the executives and the shareholders of Micron Technology? Should the project be accepted? The shareholders of Micron Technology would also like to know the meaning of NPV concept.

You may use the following steps to calculate NPV:

1) Calculate present value (PV) of cash inflow (CF)

PV of CF = CF1 / (1+r)1 + CF2 / (1+r)2 + CF3 / (1+r)3 + CF4 / (1+r)4 + CF5 / (1+r)5

2) Calculate NPV

NPV = Total PV of CF - Initial cash outflow

or

-Initial cash outflow + Total PV of CF

r = Discount rate (9%)

If you do not know how to use a calculator for these calculations, please use the present value tables.

Brealey, R.A., Myers, S.C., & Allen, F. (2005). Principles of corporate finance, 8th Edition. The McGraw−Hill. Retrieved May 2012 from http://jcooney.ba.ttu.edu/fin3322/Brealey%20Files/Appendix%20A%20-%20Present%20Value%20Tables.pdf (Use Table 1)

Part II:

Elpida Memory in Talks to Merge with Micron Technology and Nanya Technology

Rumors about potential mergers are often a hot topic in the business press. Japan's Elpida Memory (ELPDF.PK - http://ca.finance.yahoo.com/q?s=ELPDF.PK&ql=1) is in talks to merge with U.S. firm Micron Technology (NasdaqGS: MU.O - http://ca.finance.yahoo.com/q?s=MU&ql=0) and Taiwan's Nanya Technology (2408.TW - http://ca.finance.yahoo.com/q?s=2408.TW&ql=0).

As you know from reading the background materials, mergers not only can bring about great rewards, but also great risks and pitfalls. For this assignment, research the arguments both for and against such a merger from a financial perspective. For this module we are not as concerned with how consumers may fare, as this is an issue for the government to consider if it has to approve the merger. Instead, consider the question from the point of view of whether or not such a merger would be a profitable undertaking that would add value to the shareholders of three corporations (Elpida Memory, Micron Technology, and Nanya Technology).

The following article provides information on the potential mergers of Elpida Memory, Micron Technology, and Nanya Technology:

Reynolds, I., Kubo, N., Fuse, T., & Shiraki, M. (2012). Elpida in talks to merge with Micron, Nanya: Report. Retrieved August 2012 from http://www.reuters.com/article/2012/01/24/us-elpida-idUSTRE80M2IZ20120124

Do not limit yourself to this article. Use ProQuest, EBSCO Web, and other sources in the CyberLibrary. Use various Internet search engines such as news.google.com for the latest news on this merger. Look at the Web pages for Yahoo and Microsoft. Then write a 5- to 7-page report for the shareholders of Elpida Memory, Micron Technology, and Nanya Technology by answering the following questions and the questions in Part I:

1) Do you think Elpida Memory's merger with Micron Technology and Nanya Technology would add value for the shareholders of all three corporations?

2) Based on your analysis and findings (Part I and Part II), what would you recommend to the shareholders of Elpida Memory, Micron Technology, and Nanya Technology corporations? Should all three companies merge? Explain your reasoning.

The main focus of this assignment will be answering the questions above and the questions in Part I.

In your answers to the primary questions in Part II, respond to the following issues:

The impact on Elpida Memory shareholders.
The impact on Micron Technology shareholders.
The impact on Nanya Technology shareholders.
The financial conditions of all three corporations (do not forget to consider the new project proposed by Micron Technology in Part I).
Why might all three companies combined as one company be more profitable than they would if they remain independent? What are the success factors in these mergers?
Potential pitfalls: Might the combined entity actually be less profitable than the companies operating independently? What are the risk factors in these mergers?
In addition to making use of concepts from the background materials for this module, you may also use concepts from Modules 1-4.

3) What do you perceive you have learned in the Module 5 Case Assignment? Which of the following learning outcomes do you feel you have mastered?

Describe and apply net present value (NPV) method to make capital budgeting decisions.
Identify success factors in mergers and acquisitions.
Explain and discuss financing options for financing mergers and acquisitions.
Apply principles of risk and valuation analysis to mergers and acquisitions.

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Solution Summary

Solution discusses Elpida Memory's merger with Micron Technology and Nanya Technology would add value for the shareholders of all three corporations

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Capital Budgeting and Long-Term Financing Decisions

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Capital Budgeting and Long-Term Financing Decisions

1. We will open a business that requires the following three steps; we will need to find a viable location, market the product, and borrow money from the local bank. All three steps must be successful and the probability of success for the location is 70 percent, the probability of success for the successful marketing of the product is 60 percent, and the probability of success for obtaining the loan is 40 percent. The probability of joint success in all three steps is ___________.

2. Based on history, there is an .60 probability of a positive net present value when competitors do not respond to our introduction of a new product. Based on this same history, if competitors do respond, there is a .20 probability of a positive net present value. After studying history, and the financial capabilities of our competitors going forward, we determine that there is a .60 probability that competitors will respond. The total probability of a positive net present value is ______.

3. Possible net present values and associated probabilities for a new investment are as follows:
NPV -1000 -500 60 450 650 900
Probability .15 .10 .20 .10 .30 .15
What is the expected value______________, median,______________ and mode _________________?

4. Doug's Doughnuts is considering a new store location. For accounting purposes, fixed annual operating costs for a store are $85,000 a year, and variable costs are 40 percent of sales. The average sale for a customer is a doughnut and coffee which cost $5.25. The annual break-even sales level (in number of customers) for this store location is _______.

5. Teresa's Tanning Salon expects annual sales of $225,000, annual fixed cash outlays are $67,000 a year at each location, variable cash outlays are 20 percent of sales, depreciation is $15,000 per year, and taxes are 30% (of pretax income). Initial outlay for the building is $140,000. The company does its analysis based on a 10-year store life. We believe the business can be sold for $100,000 after taxes (disposal value) at the end of its 10 year lifer. Using an 14% required return, what is the net present value of this venture?

6. Please rework the prior problem to determine what annual sales volume is needed to generate a net present value of $0? To do this you will need to review the problem in the book and its excel answer. I will repeat the instructions here. You will need to calculate the net present value in the traditional wayfirst. When you do this you need to make sure that the second year sales references the first year ( plus first year in the formula) You will then do a goal seek to solve this problem The goal seek function is accessed by clicking on the data tab then the analysis tab then clicking on the what if box and then clicking on the goal seek box. To use this function, you will set the npv cell to zero by changing the sales cell.

7. As chief financial officer (CFO) of Madison Corp. you observed the price at which your bonds are selling in the market, the coupon on your bonds, and the credit rating on your debt. From this information you determine that your pretax cost of debt in 6.70%, the coupon rate is 10.5%, and the credit rating has improved from an A rating to a AA rating. In addition, Madison is in the 34% tax bracket. What is Madison's after tax cost of debt (round at 2 decimal places such as 1.45%)

8. As CFO of Mayknn Corporation you observe the preferred stock that Mayknn issued 75 years ago at a par value of $100 is now selling for $62. In addition this preferred stock now pays a dividend of $2.75. Mayknn is in the 25% tax bracket and has a credit rating of BBB. What is the after tax cost of existing preferred stock for Mayknn? (round at 2 decimal places)

9. As a young corporate financial analyst for Marshall Corporation you observe that Moody's has assigned Marshall an equity rating of AAA. In addition, Marshall's common equity is trading at $148, is expected to pay a$4.76 dividend, and is expected to grow at 6% a year. Marshall has a 15% profit margin and is expected to be in the 25% tax bracket? What is Marshall's cost of common equity? (round at 2 decimal places)

10. Using the same information as in the previous problem. If Marshall Corp. expects to pay a $3.58 in flotation cost to issue new common stock, what is the after tax cost of new common stock for Marshall? (round at 2 decimal places)

11. As a senior corporate financial analyst you were approached by the Matthew Corp.'s CFO and asked to determine the cost of common equity. You read about the Nobel prize-winning mean variance capital asset pricing model and decided to give it a try. You found the beta for Marshall is 1.40, the rate of return on long term US government bonds to be 5%, the return on short term government bonds is 2.5%, and the market risk premium over the past 70 years has averaged 5.5%. Using this data, what is Matthew's cost of equity? (round at 2 decimal places)

12. As president of Madison Corp. your finance people tell you that Madison is 25% debt and 75% common stock. In addition they tell you the cost of the common stock is 10% and the cost of the debt is 4.4%. What is Madison's weighted average cost of capital? (round at 2 decimal places)

13. Using the information is the previous problem, the president suggest that Madison take on more debt in the future to finance additional positive net present value projects. She estimates that a 60% debt and 40% equity mixture for the entire corporation is better. If Madison adopts this new debt oriented structure the cost of equity will increase to 14% and the cost of debt will increase to 7.5%. Please recalculate and report the new weighted average cost of capital and determine if Madison should stay where it is or adopt the higher debt oriented capital structure? (round at 2 decimal places)

14. TNT Corporation is considering the acquisition of BRM Corporation. TNT has 220,000 shares of stock, with earnings per share of $2 and a market price per share of $30. BRM has 250,000 shares outstanding with earnings per share of $1.20 and a market price of $10. The merger is expected to increase net income of the combined companies by $150,000. What is the maximum exchange ratio TNT can offer and what is the minimum exchange ratio BRM could accept?

15. You have been given the job of evaluating the following merger candidate. You have collected the following cash flow for the acquisition candidate for the proposed merger (in millions):
Year 1 2 3 4 5__
Cash flows now 80 85 105 145 180
Additional cash flows with merger 40 90 100 125 150
Total cash flows with merger 120 175 205 270 330

Risk free rate of return 4.5%
Beta for this project (the company after merging) 1.6
Market risk premium 5.5%
Pre-tax cost of debt 6.5%
Marginal tax rate 25%
Number of shares outstanding for the target company (millions) 20
Current market price per share for the target company $60
Percentage of the acquisition financed with debt 50%
Percentage of the acquisition financed with common equity 50%

What is the after tax cost of debt?

What is the after tax cost of common equity

What is the weighted average cost of capital for this acquisition candidate?

What is the maximum price per share you are willing to pay for this candidate?

Based on the numbers above, would you pursue this candidate?

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