Modern Golf (MG) is investigating the takeover of Pure Club Design (PCD). MG is using the discounted cash flow technique for determining PCD's takeover value and expects to achieve economies of scale in sales and marketing. In addition, it expects to realize significant external growth opportunities. MG also has synergistic expectations for PCD's alignment with a U.S. women's professional golf tour. The merger would give MG previously unavailable access to the world's best women golfers and golf courses to be used in product endorsement and marketing strategies.

Several years ago, MG hired Andrew Full, CFA, as a consultant to help in the valuation of potential target firms. Full's research was critical in MG's takeover of Perfect Putting Greens three years ago, as MG's stock price rose immediately upon announcement of the merger, and the shares have continued to perform above the industry average.

Near the end of 20X4, Full has constructed the following pro forma yearend cash flow summary (in millions of dollars):

	20X5	20X6	20X7	20X8
Net income	$500	$525	$555	$590
Depreciation expense	80	87	92	100
Capital expenditures	117	121	6	156

Full expects there to be no change in deferred taxes, a constant working capital requirement (i.e., no change), and net interest after tax to be fixed at $75 each year. Full estimates MG's weighted average cost of capital to be 10.0% and terminal growth to be 4.0%.

In his research, Full has discovered additional information and makes the following notes:

Observation 1: Pure Club Design has a share rights plan allowing its shareholders the right to buy additional PCD shares at a 50% discount to the market price if any acquiring firm purchases a minimum of 5.0% of PCD shares. The acquiring firm would not be able to participate in this purchase.

Observation 2: I recommend that MG make an allequity offer for PCD, but only before the poison pill is redeemed (canceled) by PCD's board of directors. PCD shareholders voted at the last annual meeting to rescind the poison pill, but it remains in place.

Observation 3: PCD has a pension fund for its employees. The fund assumes a discount rate that is higher than that of its competitors. We should hire an external professional to provide us with clear ideas of how this will impact our own pension fund.