M&A problem

Suppose you work as a strategic financial manager at MagicCom Inc., a large telecommunications firm which is considering making an offer to purchase SunNet Inc. a smaller network company. You were asked by the vice president of finance to assess the profitability and projected outcome of this important financial decision. For that purpose, you collected the following information:

MagicCom SunNet

Price-earnings ratio 11.5 8 Shares outstanding 1,000,000 300,000 Earnings $2,000,000 $480,000

You also know that securities analysts expect the earnings and dividends (currently $0.88 per share) of SunNet to grow at a constant rate of 3% each year. MagicCom management believes that this acquisition will generate some economies of scale increasing this growth rate to 5% per year.

A) What is the value of SunNet to MagicCom?

B) What would MagicComs gain be from this acquisition?

C) If MagicCom were to offer $15 in cash for each share of SunNet, what would the NPV of the acquisition be?

D) Whats the most MagicCom should be willing to pay in cash per share for the stock of SunNet?

E) If MagicCom offered 125,000 of its shares in exchange for the outstanding stock of SunNet, what would the NPV be?

F) As the strategic financial manager, would you recommend this acquisition and if so, should it as in C) or as in E) above?

G) MagicComs outside financial consultants think that the 5% growth rate is too optimistic and a 4% is more realistic. How would this new information change your previous answers