Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms have no debt. Penn believes

Question:

Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms have no debt. Penn believes the acquisition will increase its total after tax annual cash flow by $1.3 million indefinitely. The current market value of Teller is $27 million, and that of Penn is $62 million. The appropriate discount rate for the incremental cash flows is 11 percent. Penn is trying to decide whether it should offer 35 percent of its stock or $37 million in cash to Teller's shareholders.

a. What is the cost of each alternative?

b. What is the NPV of each alternative?

c. Which alternative should Penn choose?

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...