Franklin Corporation is a large publically traded manufacturer of pharmaceutical drugs and health equipment products with over 500 product lines. The beta for Franklin Corporation is .8. The risk free rate is 5% and the market required return is 15%. The company is headquartered in Dover, Delaware, United States.
Because of some recent setbacks, including drug R&D projects that failed, Franklin Corporation is selling off some of its assets. One asset they want to sell is XiXcon, a wonder drug for tired feet which has a patent that will expire in three years. They do not believe the patent can be re-patented. The product would have negligible value at that point. Franklin paid Washington Analytics $75,000 to confirm this information. Furthermore, there are no additional benefits or costs associated with closing the product line. XiXcon has gross sales of $600,000,000. Expenses, including marketing and distribution are typically 2/3 of sales. Depreciation for this product is $50,000,000 annually and a salvage value at the end of the third year is $100,000,000, which equals the book value. Franklin’s corporate tax rate is 35%. The state corporate tax rate is zero in Delaware.
Jackson & Jackson, Inc. has offered $400 million to Franklin for the XiXcon product. The CFO of the company, Mr. George Hamilton, proposes to use the industry wide beta for pharmaceuticals which is .5. The President and CEO of Franklin, Mr. Benji Franklin, the founding father of the company, argues that the Franklin beta should be used. He reasons that it is only fair to all the shareholders of the company that the company wide beta be used. The required rate of return is 13% for Franklin’s risk (beta of .8) and the required rate is 10% for the industry wide beta of .5.
Should Franklin sell to Hamilton? Be sure to provide not only a clear and concise numerical justification of your answer, but also a compelling rational of why Franklin should or should not accept the offer.