Question1 :

Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading at $20 per share. Rearden Metal is planning to acquire Associated Steel, which has earnings per share of $1.25, 4 million shares outstanding, and a price per share of $15. Both companies have no debt in their capital structure.

Assuming that Rearden Metal seeks an independent valuation from an external financial analyst. The analyst estimates that Rearden Metal will increase its revenue with a net cash flow of $500,000 per annum in perpetuity after acquiring Associated Steel. The cost of capital of Rearden Metal is 10% per annum. Rearden Metal will pay for Associated Steel by cash payment and the offer price is $70 million.

(i) What is the stock price of Rearden Metal and what is the stock price of Associated Steel after the announcement of the takeover? Explain why there is an increase or a decrease in stock prices each of these two firms after the announcement of the takeover?

(ii) What is the net present value (NPV) of this takeover to Associated Steel and what is the net present value (NPV) of this takeover to Rearden Metal?