A sporting goods manufacturer has decided to expand into a related business. Management estimates that to build and staff a facility of desired size and to attain capacity operations would cost $450 million in current value terms. otherwise, the company could get an existing firm or division with the desired capacity. One such opportunity is division of another company. The book value of the division's assets is $250 million, and its earnings before interest and tax are currently $50 million. Publicly trade comparable companies are selling in a narrow range around 12times existing earnings. These companies have book value debt-to-asset ratios averaging 40 % with an average interest rate of 10 %.
a. Using a tax rate of 34 %, evaluate the minimum price the owner of the division should consider for its sale.
b. Find the maximum price the acquirer should be willing to pay?
c. Does it seem that an acquisition is feasible? Why or why not?
d. Would a 25 % increase in stock prices to an industry average price-to-earnings ratio of 15 change your answer to (c)? Why or why not?
e. Referring to $450 million price tag as replacement value of the division, what would you predict would happen to acquisition activity when market values of companies and divisions raise above their replacement values?