Many managements apparently are overexposed in impressionable childhood years to the story in which the imprisoned, handsome prince is released from the toads body by a kiss from the beautiful princess. Consequently, they are certain that the managerial kiss will do wonders for the profitability of Company T (target). Such optimism is essential. Absent that rosy view, why else should the shareholders of Company A (acquisitor) want to own an interest in T at the 2X takeover cost rather than at the X market price they would pay if they made direct purchases on their own? In other words, investors can always buy toads at the going price for toads. If investors instead bankroll princesses who wish to pay double for the right to kiss a toad, those kisses had better pack some real dynamite. Weve observed many kisses, but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses even after their corporate backyards are knee-deep in unresponsive toads.

Task:

Company A (acquisitor), a growing computer software developer, wishes to determine the required return of Company T (target), which has a beta of 1.5. The risk-free rate of return is 7%; the return on the market portfolio of assets is 11%.

Using the capital asset pricing model (CAPM) as a valuation model, calculate the value of a share of Company T (target) and advise on the considerations you would take into account to determine if its a good acquisition or not.