As CFO of Frankfurter Rindswurst AG (FR) you are investigating the possible acquisition of Nurnberger Rostbratwurst AG (NR). You have the following basic data:

FR

NR

Expected earnings per share (EPS₁)

5.00

1.50

Expected dividend pear share (DIV₁)

3.00

0.80

Number of shares outstanding

1,000,000

600,000

Stock price today (P₀)

90

20

You estimate that investors currently expecte a steady growth of about 6% in NR's earnings and dividends. Under new management this growth rate would be increased to 8% per year, without any additional capital investment required.

a.What is the gain from the acquisition?

b. Define net cost = value of cash or stock paid - standalone value of the target firm NR.

What is the net cost of acquisition if FR pays 25 in cash for each share of NR?

c. What is the net cost of acquisition if FR offers ons share of FR for every three shares of NR?

d. How would the net cost of the cash offer and the share offer alter if the expected growth rate of NR was not changed by the merger?

In the question, the current stock price P₀is 20 for NR. The expected year one dividend DIV₁is 0.80 for NR. Use the constant growth model (Gordnon growth model) to find the cost of equity for NR and firm value under the new growth rate for NR first. The value of the acquiring firm FR is unaffected by the merge.