Question: Moon Shine has decided to expand into related business. Management estimates that to build a facility of the desired size and to attain capacity operations would cost $ 285 million in present value terms
Alternatively, the firm could acquire an existing division with the desired capacity. One such opportunity is the division of another company. The book value of the division's assets is $145 million and its earnings before interest and tax are $30 million. Publicly traded comparable companies are selling around 12 times current earnings. These companies have debt-to-asset ratios averaging 40 percent with an average interest rate of 10 percent.
a) Minimum price the owner of the division should consider for its sale, using a tax rate of 34 percent.
b) Maximum price the acquirer should be willing to pay.
c) Does it appear that an acquisition is feasible?
d) Would a 25 percent increase in stock prices to an industry average price-to-earnings ratio of 15 change your answer to (c)?
e) Referring to the $285 million price tag as a replacement value of the division, what would you predict would happen to acquisition activity when market values of companies and division rise above their replacement values?