Q5.Foxy News (currently trading at $50/share) is considering purchasing its rival Pulitzer Publications. Both firms currently have 1,000,000 shares outstanding and Pulitzer generates $1,500,000 in free cash flows each year. Foxy estimates that synergies between the two firms would generate another $100,000 each year in free cash flows as well as increase growth in Pulitzerâs business from 5% to 6% each year (the appropriate discount rate for Pulitzer is 10%). Foxyâs management is considering whether to offer straight cash for each share of Pulitzer or whether to offer their target a 40% stake in the combined firm.If Pulitzer’s shareholders are indifferent between a cash purchase and an equity-backed purchase, at what price per share would the shareholders of Pulitzer be indifferent between the two offers? (4 marks)Why are straight cash offers often preferred over purchases made with common stock or even combined cash/stock offers? (2 marks)Why would a hostile takeover offer be more likely to misprice a target acquisition than a friendly acquisition? (2 marks)Why are the average prices of firms with shareholder rights plans (aka poison pills) generally lower than those without such means to fend off hostile takeovers? (2 marks)Question 6 (10 marks)Kester Limited is an all equity firm that is considering the acquisition of Lignite Corporation. Kester’s market capitalization is $30 million and it has 600,000 shares outstanding. Lignite’s market capitalization is $3.5 million. After the merger, Kester’s executives estimate that the combined company will experience an immediate, permanent increase in annual profit of $100,000. Kester will use a 12.5% cost of capital to evaluate the proposed acquisition. Because of the friendly nature of the merger, Kester has made two offers to the shareholders of Lignite Corporation: one for $3.95 million in cash, the other for 75,000 shares of the merged company.Assuming a no-tax environment, which of the two offers are Lignite’s shareholders likely to prefer? (2 marks)Calculate Kester’s share price assuming that each offer is accepted (report both prices) (4 marks)What is the minimum level of yearly synergies Kester needs to achieve in order to justify the greater of the two offers they have made? (2 marks)Assume now that Kester also expects to incur integration costs related to the merger of $200,000. What is the yearly minimum synergies that must be achieved in order to justify the higher bid? (2 marks)
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