Question
Use the following information to answer the next six questions: Bright EyesInc. specializes in developing and manufacturing contact lenses. The company's executives believe that they
Use the following information to answer the next six questions:
Bright EyesInc. specializes in developing and manufacturing contact lenses. The company's executives believe that they can achieve more rapid growth by making acquisitions that create synergies via cost savings. Brian Townsend, CFA has been hired by Bright Eyesas a consultant to analyze potential targets. After his initial research, Townsendhas identified two potential targets:
1. Fenner,Inc. Fenner develops, manufactures, and markets common types of contact lenses in the US and Canada. In a potential merger, all assets and liabilities of Fenner will be absorbed by Bright Eyes.
2. EdgartonLenses Inc. Edgartonis well known among ophthalmologists for manufacturing long-term wear lenses for low-vision patients. In an acquisition, Bright Eyeswants to keep Edgarton's successful brand name.
After extensive discussionswith the management team, Townsendconcludes that a merger offer for Fenner would be most beneficial to Bright Eyesdue to its estimated $100 million cost savings synergies. Bright Eyesagrees to offer $380 million cash for Fenner.
RonnieTomkins, CEO of Edgartonis concerned that Bright Eyesmay initiate a possible hostile takeover of his firm. He sets up a meeting with other Bright Eyesexecutives to discuss possible defense mechanisms. In the meeting Tomkinsclaims "as a pre-takeover defense we may be able to use poison puts which give rights to our bondholders to sell their bonds back to the company typically at or above par value. This defense increases the cost of the acquisition to the acquirer." George Windhorst, VP for Operations agrees and adds:
"Once the takeover is initiated, we may be able to use the greenmail technique, an agreement allowing our shareholders to repurchase our own shares back from Bright Eyesat a discount to the market price."
Bright Eyescurrently has 20 percent of the contact lenses market while Fenner has a 10 percent market share. Bright Eyes'management, however, is quite concerned that a merger with Fenner may trigger anti-trust regulators to scrutinize the merger deal. There are eight other firms in the industry. The largest firm, Clear Eyes, has 30 percent of the market. Jefferson and Lesleyeach have 10 percent of the market. Five other smaller firms each have 4 percent of the market. Fenner has 20 million shares outstanding and the pre-merger stock price is $15 a share.
The company has no debt. Townsendhas projected that the post-merger free cash flows from Fenner, in millions of dollars, would be 12, 15, 20, and 24 at the end of the next four years, respectively. After year 4, he projects free cash flows to grow at a constant rate of 7 percent per year. The required rate of return for Bright Eyesand Fenner are 10 and 12 percent respectively.
While discussing his analysis with a colleague, the colleague makes the following two statements:
Statement 1: "For a rapidly growing firm like Fenner, it is difficult to value the target using the discounted free cash flow approach because of heavy capital expenditures and the possibility of negative free cash flows. I suggest that you consider the comparable company analysis approach instead."
Statement 2: "Recent volatilities in the capital markets will affect the estimates of discount rates which in turn will affect acquisition estimates significantly."
7. Which of the following forms of mergers characterize the acquisitions of Edgartonand Fenner by Bright Eyes, respectively?
A. Edgarton: Statutory and horizontal; Fenner: Subsidiary and horizontal
B. Edgarton: Subsidiary and horizontal; Fenner: Statutory and horizontal
C. Edgarton: Subsidiary and vertical; Fenner: Subsidiary and vertical
8. Are suggestions made by Tomkinsand Windhorstregarding poison puts and greenmail correct?
A. Tomkins's Statement: Yes; Windhorst's Statement: Yes
B. Tomkins's Statement: Yes; Windhorst's Statement: No
C. Tomkins's Statement: No; Windhorst's Statement: No
9. If Bright Eyesand Fenner continue with their merger plans, the increase in Herfindahl-Hirschman (HHI) and the probable action by the FTC, respectively, in response to the merger announcements are:
A. Increase in HHI: 900; Probable Response of FTC: challenge
B. Increase in HHI: 400; Probable Response of FTC: challenge
C. Increase in HHI: 400; Probable Response of FTC: possible challenge
10. The present value per share of Fenner stock using the discounted cash flow model is closest to:
A. $18.93
B. $17.86
C. $20.27
11. Are the two statements made by Foley's colleague correct?
A. Both statements are correct.
B. Both statements are incorrect.
C. Statement 1 is correct, and statement 2 is incorrect.
12. Suppose Bright Eyesacquires Fenner for the stated terms. The gain to Fenner's shareholders and Bright Eyes' shareholders resulting from the merger would be closest to:
A. Fenner's Owners Gain: $180 million; Bright Eyes'Owners Gain: $100 million
B. Fenner's Owners Gain: $80 million; Bright Eyes'Owners Gain: $100 million
C. Fenner's Owners Gain: $80 million; Bright Eyes'Owners Gain: $20 million
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