Question:
Canon Burger has been expanding its operation rapidly by acquiring a number of restaurants. Canon has been funding its acquisitions by bank borrowing and it has a high level of gearing. Canon Burger has been specialising in fast food outlets and although the market is supported by a booming young population, the older generation prefer more traditional outlets. Canon is considering the acquisition of Templar Restaurant, a continental type of establishment with a steady clientele and good reputation. The owners of Templar have been rather conservative and have not exploited the brand value of the restaurant to expand, as they approach retirement. The owners of Templar are prepared to accept a cash offer of $200,000.
Canon Burger has a cost of capital of 16 percent due to its high gearing. Templar Restaurant on the other hand is free of debt. As a result of the acquisition, Canon Burger expects the debt equity ratio of the combined equity to decrease and the cost of capital to fall to 12 percent. The acquisition of Templar Restaurant is expected to increase Canon's cash flow by $25,000 per year forever.
(a) Assess the synergies that the acquisition of Templar Restaurants should create.
(b) Recommend whether Canon Burger should proceed with the acquisition.
(c) If the acquisition was funded by borrowing so that there is no impact on the level of gearing of the combined entity and the cost of capital was not reduced, recommend whether Canon should still proceed with the acquisition.