As the financial manager of Global Toys, Inc., you are examining the possible acquisition of a smaller toy company called Games for All. You have the following basic financial information about both companies:

Global Toys Games for All

Price-earnings ratio 15 12

Number of shares 1,000,000 250,000

Earnings $1,000,000 $750,000

You also know that investors and analysts expect the earnings and dividends (currently $1.80 per share) of Games for All to grow at a constant rate of 5% each year. However, your research indicates that the acquisition should provide Games for All with some economies of scale which would raise this growth rate to 7% per year.

A) What is the value of Games for All to Global Toys? (8 points)

B) If Global Toys offers $40 in cash for each outstanding share of Games for All, what would the NPV of the acquisition be? (4 points)

C) If instead Global Toys offers 600,000 of its shares in exchange for the outstanding stock of Games for All, what would the NPV of this acquisition be? (8 points)

D) Interpret your results in B) and C) above and make your recommendation with regard to how the acquisition should be made (cash or stock)? (5 points)