Question 1

Company A plans to acquire Company B. The acquisition would result in incremental cash flows for Company A of R15 million in each of the first five years. Company A expects to divest from Company B at the end of the fifth year for R100 million. The beta for Company A is 1.1, which is expected to remain unchanged after the acquisition. The risk-free rate, Rf, is 7 percent, and the expected market rate of return, Rm, is 15 percent. Company A is financed by 80 percent equity and 20 percent debt, and this leverage will also remain unchanged after the acquisition. Company A pays interest of 10 percent on its debt, which will remain unchanged after the acquisition.

1.1) Disregarding taxes, what is the maximum price that Company A should pay for Company B?

1.2)Company A has a share price of R35 per share and 15 million shares outstanding. If Company B shareholders are to be paid the maximum price determined in (1.1) via a new share issue, how many new shares will be issued, and what will be the post-merger share price? (5)