Problem:
Freeport Manufacturing is considering making an offer to purchase Portland Industries. The treasurer of Freeport has collected the following information:
Freeport Portland
Price-earnings ratio 15 12
Number of Shares $1,000,000 $250,000
Earnings $1,000,000 $750,000
The treasurer also knows that securities analysts expect the earnings and dividends (currently $1.80 per share) of Portland to grow at a constant rate of 5 percent each year. Her research indicates, however, that the acquisition would provide Portland with some economies of scale that would improve this growth rate to 7 percent per year.
Q1. What is the value of Portland to Freeport?
Q2. If Freeport offers $40 in cash for each outstanding share of Portland, what would the NPV of the acquisition be?
Q3. If instead Freeport were to offer 600,000 of its shares in exchange for the outstanding stock of Portland, what would the NPV of the acquisition be?
Q4. Should the acquisition be attempted, and if so, should it be a cash or stock offer?
Q5. Freeport's management thinks that 7-percent growth is too optimistic and that 6 percent is more realistic. How does this change your previous answers?