CORPORATE FINANCE (FIN3CFI)Tutorial Questions

Tutorial questions are selected from the fourth edition of the textbook, with some modification. Note the following terms: CQ refers to concept questions provided at the end of sub-sections within chapters; EOCQ refers to questions provided in Questions and Problems at the end of each chapter of the fourth edition.

TUTORIAL 1
CHAPTER 1: INTRODUCTION TO CORPORATE FINANCE 1. 2. CQ 1.3c) Why is the corporate form superior when it comes to raising cash? CQ 1.4a) What is the goal of financial management?

3. CQ 1.5b) What are agency problems and how do they come about? What are agency costs? 4. EOCQ 2) Evaluate the following statement: Managers should not focus on the current share value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits. 5. EOCQ 12) Assume a perfect certainty two-period world. Jeff Rush Dramas(JRD) has the following investment opportunities available: Project Outlay IRR% 1 $110,000 22 2 $ 60,000 30 3 $76,000 9 4 $90,000 17 5 $93,000 6 The market rate of interest is 10 per cent. a. If JRD had an initial endowment of $500,000 and undertook all desirable projects, what would be the value of JRD? b. J Low is a shareholder of the firm and she owns 10%. What dividend would she receive in period 1 and period 2 if the firm undertakes all desirable investments? c. Assume the dividends are the only income J Low receives and JRD plans to pay $23,000 in period 1 and $32,850 in period 2 to her. If she requires $50,000 in period 1, how much will she have available to spend in period 2?

CHAPTER 2: FINANCIAL STATEMENTS, TAXES AND CASH FLOW 6. EOCQ 15) Alice Ltd has 5 million shares on issue, selling at $2.30 each. Its Balance Sheet shows net assets as $12.4 million. What is the difference between market and book value? Which is more relevant? Why?

TUTORIAL 2
CHAPTER 7 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 1. EOCQ 9) If a project has conventional cash flows and a positive NPV, what do you know about its benefit/cost ratio? IRR? Which will be the shortest and which will be the longest when we compare the payback, the projects life and the discounted payback? 2. EOCQ 10) Compute the internal rate of return on a project with the following cash flows Year Cash flow 0 -$24,000 1 22,000 2 4,840 Assume the project is undertaken and it is found that the total outlay at the beginning was only $21,694.44. What is the revised IRR? 3. EOCQ 17) Cautious Ltd is examining a three-year investment but it is not sure which evaluation technique to use. The following information has been collected for the investment: Year Cash flow 0 -$100 1 50 2 40 3 60 Help Cautious by completing the table assuming an 8% required return and answering the questions that follow the table. Cash flows and accumulated cash flows Cash flow Accumulated cash flow Non-discounted Discounted Non-discounted Discounted

Year 1 2 3

a. What is the payback rounded up to the next whole year? What is the payback if we use fractional years? What are we assuming about the cash flows when we calculate the fractional year? b. What is the discounted payback? Dont calculate the fractional year. c. What is the NPV of this investment if the required return is 8%? d. What is the NPV of this investment if the required return is 10%? e. What is the NPV of this investment if the required return is 6%? f. Do you think computing the three techniques of evaluation helped Cautious?

CHAPTER 8: MAKING CAPITAL INVESTMENT DECISIONS 4. EOCQ 8) A new security process monitor costs $140,000. This monitor will be depreciated at a diminishing value rate of 30%. The monitor will be worthless in 5 years but it will save theft of $40,000 per year before taxes. The required rate of return is 10% and the rate of tax is 30%. What is the NPV of the purchase if the tax is paid in the year the income is earned? 5. EOCQ 9) Len Lite and Henry Heavy are considering building a new bottling plant to meet expected future demand for their new line of orange ales. They are considering putting it on a plot of land they have owned for three years. They are in the process of analysing the idea and comparing it with some others. Lite says, H, when we do this analysis, we should put in an amount for the cost of the land equal to what we paid for it. After all, it did cost us a pretty penny. Heavy retorts, No, I dont care how much it cost we have already paid for it. It is what they call a sunk cost. The cost of the land shouldnt be considered. What would you say to Lite and Heavy? 6. EOCQ 19) This is a challenge problem. Icy Co. has recently completed a $400,000, 2-year marketing study. Based on the result, Icy has estimated that 10,000 of its new cold rooms could be sold annually over the next 8 years at a price of $9615 each. Subcontractors would install the cold rooms at a cost per installation of $7400. Fixed costs to be incurred would be $12 million per year. Start-up costs include $40 million to build production facilities and $2.4 million in land. The $40 million facility will be depreciated prime cost to zero over the projects life. At the end of the projects life, the facility (including the land) will be sold for an estimated $8.4 million. The value of the land is not expected to change. Finally, start-up would also entail fully deductible expenses of $1.4 million at year zero. Icy is an ongoing, profitable business and pays taxes at a 30% rate in the year of income on all income and gains. Icy uses a 10% discount rate on projects such as this one. Should Icy produce the cold rooms?

TUTORIAL 3
CHAPTER 7: NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 1. EOCQ 18) Consider the following cash flows on two investments: Year Investment A Investment B 0 -$100 -$100 1 44 69 2 56 51 3 65 32 a) The required return is 15%. The investments are not mutually exclusive. Calculate the NPV and IRR on both. Are they desirable? b) Now suppose you wanted to combine the two investments into a single investment C. Calculate the combined cash flows. What is the NPV of C? How does this NPV relate to the NPVs for A and B considered separately? Based on your answer, is there an obvious shortcut that we could have used to calculate the NPV of C? c) Based on the combined cash flows, calculate the IRR for C. How does your answer relate to the IRRs for A and B? Is there an obvious shortcut that we could have used?

CHAPTER 8: MAKING CAPITAL INVESTMENT DECISIONS 2. EOCQ 14) Power Ltd is looking at producing electronic chips for financial calculators. The company is considering alternative production methods. The costs and lives associated with each are: Year Method 1 Method 2 0 $100,000 $90,000 1 2,000 8,000 2 2,000 8,000 3 2,000 8,000 4 8,000 Assuming that Power will not replace the equipment when it wears out, which should it buy? If it is going to replace it, which should it buy (r = 10%)? Ignore depreciation and taxes in answering and answer this question by three methods: AEC, LCL and NPV. 3. EOCQ 15) In the previous question, suppose that all the costs are before taxes and the tax rate is 30%. The equipment used in method 1 will be worth $12,000 in salvage in 3 years. Both will be depreciated prime cost at 30%. Method 2 will generate a $16,000 salvage value. Tax is paid in the year of income. What are the AECs in this case? Which is the preferred method?

4. EOCQ 17) Bigtime Ltd is thinking about replacing an old computer with a new one. The old one cost $50,000; the new one will cost $35,000. The new machine will be depreciated prime cost to zero over its 5-year life. It will probably be worth about $5000 after 5 years. The old computer is being depreciated at a rate of $5000 per year. It will be completely written off in 5 years. If Biftime does not replace it now, it will have to replace it in 5 years. Bigtime can sell it now for $12,000. In five years, it will probably be worth nothing. The new machine will save $6000 per year in cooling costs. The tax rate is 30%, tax is paid in the year of income, and the discount rate is 10%. Should Bigtime purchase the new computer?

TUTORIAL 4
CHAPTER 9: PROJECT ANALYSIS AND EVALUATION 1. CQ 9.6a) Why do we say that our standard discounted cash flow analysis is static? 2. EOCQ 19) We are examining a new project. We expect to sell 500 units per year at $18 net cash flow each for the next 10 years. In other words, the annual operating cash flow is projected to be $18 500 = $9,000 per year. The relevant discount rate is 18% and the initial investment is $50,000. Ignore taxation. What is the base-case NPV? 3. EOCQ 20) Use the information from question 2. After the first year, the project can be dismantled and sold for $36,000. If expected sales are revised based on the first years performance, when would it make sense to abandon the investment? In other words, at what level of expected sales would it make sense to abandon the project? 4. EOCQ 22) Use the information from question 2. Suppose you think it is likely that expected sales will be revised up to 750 if the first year is a success and revised down to 400 if the first year is not a success. a) If success and failure are equally likely, what is the NPV of the project? Consider the possibility of abandonment in answering. b) What is the value of the option to abandon?

CHAPTER 23: LEASING 5. CQ 23.2a) What are the differences between an operating lease and a financial lease? 6. CQ 23.4a) Is it true that borrowing to purchase is preferred to leasing because depreciation and interest payments are allowable deductions if the asset is to be used in producing assessable income? Why or why not? 7. CQ 23.6c) Why shouldnt we use the risk-free rate as the interest rate for the economic evaluation of leases? 8. EOCQ 6) Clear Photography Pty Ltd requires a new developing press which will cost $500,000. This press will greatly reduce turnaround time and allow Clear to compete favourably. The expected useful life of the press is 3 years. Because of the nature of the photography industry, customers are slow in paying their accounts so that Clear has a cash flow problem. Nevertheless Clears bank has arranged for an associated finance company to lend Clear the funds at 10 per cent. As Clears marginal tax rate is 30% per cent, the after-tax cost of borrowing is 7 per cent. The rate of 10 per cent is felt to be justified in the current market situation. The expected useful life of a press is only 3 years because of technological advances, so that at the end of 3 years the press is expected to have a salvage value of $40,000;

however, depreciation over the same period will be allowed for tax purposes at 40 per cent diminishing value. If Clear borrows to purchase, repayment of the debt will be in 3 equal annual instalments paid at the end of each year. As an alternative to borrowing to purchase the machine the company could lease through Taxsaver Leasing Ltd. If the press is leased the annual premium is $144,000 for a 4-year period with the premium being paid at the beginning of each year. The lease is to have a zero residual value clause. Regardless of which method of financing is used, the contract will be signed on 1 Julythe beginning of the companys tax year. It may be assumed that all tax payments are made at the end of the year in which the expense is incurred. a. Present an analysis to show which method of financing Clear should use. b. The bank manager insists that Clear should borrow to purchase, since this method provides the entire $500 000 required for the press, whereas, if Clear leases, it will be necessary for Clear to find the first lease payment of $144,000 outside the lease. Is this a valid criticism of the leasing alternative?

TUTORIAL 5
CHAPTER 15: LONG-TERM FINANCING: AN INTRODUCTION 1. CQ 15.1a) What are the distinguishing features of debt as compared to equity? 2. EOCQ 4) Joseph Retailing Ltd wants to elect directors to the board of Stationery Supplies Ltd. What percentage of shares would Joseph need to acquire to be reasonably sure of electing four directors to the board of six? Does it make any difference to your answer if Stationery is a private company? 3. EOCQ 5) Which have a higher yield, preference shares or corporate debentures? Why is there a difference? Who are the main investors in preferences shares? Why? 4. EOCQ 9) A petition for the receivership of the Tape View Company Pty Ltd has been filed. The liquidator estimates that the firms liquidation value, after considering costs, is $31 million. Alternatively, the directors, using the analysis of the Lucas Consulting firm, predict that the reorganised business will generate $7 million annual cash flows in perpetuity. The discount rate is 20%. Should Tape View be liquidated or reorganised? Why? 5. EOCQ 11) What is the effect of each of the following provisions on the coupon rate for a newly issued debenture? Give a brief explanation in each case. a) A call provision b) A convertibility provision c) A put provision d) A floating coupon

CHAPTER 16: ISSUING SECURITIES TO THE PUBLIC 6. CQ 16.1a) Why is an initial public offering (IPO) necessarily a cash offer? 7. CQ 16.2b) Suppose a sharebroker calls you up out of the blue and offers to sell you all the shares you want of a new issue. Do you think the issue will be more or less underpriced than average? 8. EOCQ 4) In 200X, a certain associate professor of finance bought 12 initial public offerings of ordinary shares. He held each of these for approximately one month and then sold. The investment rule he followed was to submit a purchase order for every initial public offering of oil and gas exploration companies with a firm commitment underwriting agreement. There were 22 of these offerings, and he submitted a purchase order for approximately $1000 for each of the companies. With 10 of these, no shares were allocated to him. With five of the 12 offerings that were purchased, fewer than the requested number of shares were allocated.

The year 200X was very good for oil and gas exploration company owners. On average, of the 22 companies that went public, the shares were selling for 80 per cent above the offering price a month after the initial offering date. The associated professor looked at his performance record and found the $8400 invested in the 12 companies had grown to only $10 000, a return of only about 20 per cent (commissions were negligible). Did he have bad luck, or should he have expected to do worse than the average initial public offering investor? Explain.

10

TUTORIAL 6
CHAPTER 16: ISSUING SECURITIES TO THE PUBLIC 1. CQ 16.3a) What are some possible reasons why the price of shares drops on the announcement of a new equity issue? 2. CQ 16.5e) Does a rights offer cause a share price decrease? How are existing shareholders affected by a rights offer? 3. EOCQ 9) Overland Motor Organization (OMO) has just made a 1 for 4 bonus issue to have 96 million shares on issue. It is now preparing to raise $36 million through a rights issue. The firm needs the funds to finance purchases of new mineral deposits. After public announcement the share price steadied at about $7.00 per share. OMOs financial staff have proposed two plans plan As subscription price is $6 while plan Bs price is $3.00. Assuming that both plans are successful: a) Determine the number of shares issued under each plan. b) How many shares currently held will be required to purchase a new share? c) What should be the ex rights price of the shares in each plan? d) What should be the value of a right in each plan? e) Which plan is preferable? Why? f) Which plan would you recommend to OMO? Why? 4. EOCQ 12) Lurid Co. Ltd has just gone public. Under the fixed commitment agreement, Lurid received $1.50 for each of the 40 million shares sold. The initial offering price was $1.60 per share, and the share rose to $1.80 per share in the first few minutes of trading. Lurid paid $100,000 in direct legal and other costs. Indirect costs were $60,000. What was the flotation cost as a percentage of funds raised? CHAPTER 17: COST OF CAPITAL 5. CQ 17.1a) What is the primary determinant of the cost of capital of an investment? 6. CQ 17.2a) What do we mean when we say that a corporations cost of equity capital is 16 per cent?

11

7. EOCQ 1) Equity in Retail Online Trading (ROT) Pty Ltd has a beta of 0.9. The market risk premium is 8%, and the risk-free rate is 4%. ROTs last dividend was $0.40 per share, and the dividend is expected to grow at 8% indefinitely. The shares currently sell for $13.50 per share. Calculate ROTs cost of equity capital using two different methods. Comment on the answers obtained using the two methods to suggest which is the preferred answer. 8. EOCQ 7) Luke Lucky, president of Lucky Enterprises Pty Ltd, is trying to determine Luckys cost of debt and cost of equity. He is not having an easy time of it. a) The shares currently sell for $4 per share, and the dividend per share will probably be about $0.40. Luke argues, It will cost us $0.40 per share to use the shareholders money this year, so the cost of equity is equal to 10% ($0.40/$4.00). What is wrong with this conclusion? b) Based on the most recent financial statements, Luckys total liabilities are $8 million. Luckys total interest bill will be approximately $1 million for the coming year. Luke therefore reasons, We owe $8 million, and we will pay $1 million interest. Our cost of debt is obviously $1 million/$8 million = 12.5%. What is wrong with this conclusion? c) Based on his analysis, Luke is recommending that Lucky increase its use of equity because debt costs 12.5%, but equity only costs 10%, so equity is cheaper. Ignoring all the other problems, what do you think about the conclusion that the cost of equity is less than the cost of debt?

12

TUTORIAL 7
CHAPTER 17: COST OF CAPITAL 1. CQ 17.4c) Under what conditions is it correct to use the WACC to determine NPV? 2. CQ 17.5b) What is the pure play approach to determining the appropriate discount rate? When might it be used? 3. EOCQ 13) Russ Cooking Supply Ltd currently has 30 million shares outstanding. The shares sell for $4. The firms debt is publicly traded and was recently quoted at 80% of face value. It has a total face value of $30 million, and it is currently priced to yield 8%. The risk-free rate is 4%, and the expected market return is 16%. You have estimated that Russ has a beta of 1.5. If the corporate tax rate is 30%, what is Russs WACC? 4. EOCQ 15) Cent Investments Ltd is considering a project that will result in initial cash savings of $5 million at the end of the first year, and these savings will grow at the rate of 3.2% per year indefinitely. The firm has a debt/equity ratio of 4.0, a cost of equity of 12%, and an after-tax cost of debt of 6%. The cost-saving proposal is closely related to the firms core business, so it is viewed as having the same risks as the overall firm. Under what circumstances should the firm take on the project? 5. EOCQ 20) The Mark Models Company Ltd (MML) is contemplating a $20 million expansion project in its models division. It has forecast after-tax cash flows for the project of $8 million per year in perpetuity. The cost of debt capital for MML is 8 per cent, and its cost of equity capital is 16 per cent. The tax rate is 30 per cent. Mark Might, the companys chief financial officer, has come up with two financing option: 1) $20 million issue of 10-year debt at 8 per cent interest. The issue costs would be 1 per cent of the amount raised. 2) A $20 million issue of ordinary shares. The issue costs of the shares would be 15% of the amount raised. The target debt/equity ratio of Mark Models is 3. The expansion project will have about same risk as the existing business. Mr. Mark has advised the company to go ahead with the new project and to use debt because debt is cheaper and the issue cost will be less with debt. a) Is Mr Might correct? b) What is the NPV of the new project?

13

TUTORIAL 8
CHAPTER 19: FINANCIAL LEVERAGE AND CAPITAL STRUCTURE POLICY 1. CQ 19.1a) Why should financial managers choose the capital structure that maximises the value of the firm? 2. CQ 19.2a) What is the impact of financial leverage on shareholders? 3. EOCQ 1) Corn Company Ltd is being set up with no debt and it will have a total market value of $500 000. Earnings before interest and taxes (EBIT) are projected to be $60 000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 20 per cent higher. If there is a recession, then EBIT will be 40 per cent lower. Corn is also considering a $250 000 debt issue with an 8 per cent interest rate. If the debt issue goes ahead, fewer shares will be issued. The original plan is to issue 500 000 shares and no debt. a) Calculate earnings per share (EPS) under each of the 3 economic scenarios before any debt is issued. Also calculate the percentage change in EPS if the economy expands or enters a recession. b) Repeat part a) assuming that Corn goes through with its plan to issue debt. What do you observe? Ignore taxation in your answer. 4. EOCQ 5) Here Pty Ltd and Now Pty Ltd are identical firms in every way except for capital structure (Now uses perpetual debt). The EBIT for both is expected to be $16 million forever. The shares of Here are worth $100 million, and the shares of Now worth $50 million. The interest rate is 8 per cent, and there are no taxes. Awake owns $1 million of Nows shares. a) What rate of return is Awake expecting? b) Show how Awake could generate exactly the same cash flow and rate of return by investing in Here and using home-made leverage. c) What is the cost of equity for Now? Compare your answer to your answer in part a). What do you notice? Explain? d) What is Heres weighted average cost of capital? What is the weighted average cost of capital for Now? What principle does your answer illustrate? 5. EOCQ 16) Road Co Pty Ltd is an all-equity business with a beta of 0.80. The market return is 16 per cent, and the risk-free rate is 6 per cent. Management is considering a change in capital structure that will result in a debt/equity ratio of 2. The debt will have no systematic risk, and there are no taxes. a) What is Roads cost of equity before the debt issue? b) What is Roads cost of equity after the debt issue? c) What is WACC before and after the debt issue? d) What is the beta for Roads equity after the debt issue?

14

6. EOCQ 22) Shine has a WACC of 16%, its cost of debt is 8% and it has a debt-equity ratio of 0.8. Ignoring taxes, what is Shines cost of equity?

15

TUTORIAL 9
CHAPTER 19: FINANCIAL LEVERAGE AND CAPITAL STRUCTURE POLICY 1. CQ 19.4a) What is the relationship between the value of an unlevered firm and the value of a levered firm once we consider the effect of corporate taxes? 2. CQ 19.6a) Describe the trade-off that defines the static theory of capital structure. 3. CQ 19.8c) What are franking credits? Are they different from imputation credits? 4. EOCQ 10) Far Manufacturing Ltd has no debt, and its WACC is currently 16%. Far can borrow at 10%. The corporate tax rate is 30%. a) What is Fars cost of equity? b) If Far converts to 25% debt, what will its cost of equity be? c) If Far converts to 50% debt, what will its cost of equity be? d) What is Fars WACC in part b)? In part c)? 5. EOCQ 14) Fudge Real Estate Ltd currently uses no debt. EBIT is expected to be $8,000 forever, and the cost of capital is currently 14%. The corporate tax rate is 30%. a) What is the market value of Fudge Real Estate? b) Suppose Fudge floats a $20,000 debt issue and uses the proceeds to reduce share capital. The interest rate is 8%. What is the new value of the business? What is the new value of the equity? 6. EOCQ 18) This one is a little harder. The Chimp Company Ltd expects an EBIT of $9,000 every year forever. Chimp currently has no debt and its cost of equity is 14%. Chimp can borrow at 10%. If the company tax rate is 30%, what is the value of the firm? What will the value be if Chimp converts to 100% debt?

16

TUTORIAL 10
CHAPTER 18: DIVIDENDS AND DIVIDEND POLICY 1. CQ 18.1c) How should the price of a share change when it goes ex-dividend? 2. CQ 18.3a) What are the tax benefits of high dividends? 3. CQ 18.5a) How does the market react to unexpected dividend changes? What does this tell us about dividends? About dividend policy? 4. EOCQ 6) All of the shareholders of Offshore live outside Australia, it has declared a $0.20 per share dividend. Suppose that capital gains are not taxed, but dividends are taxed at 30%. Australian Tax Office withholding regulations require that taxes be withheld at the time the dividend is paid. Offshore sells for $2 per share and the share is about to go ex dividend. What do you think the ex dividend price will be? 5. EOCQ 11) Clear View Ltd predicts that earnings in the coming year will be $10 million. There are 10 million shares outstanding, and Clear maintains a total debt ratio of 0.50. a) Calculate the increase in total value if all the earnings are invested and the total debt ratio is maintained. What is the resultant increase in borrowing? b) Suppose Clear View uses a residual dividend policy. Planned capital expenditures total $12 million. Based on this information, what will the dividend per share amount be? c) In part (b), how much borrowing will take place? What are retained earnings? d) Suppose Clear plans no capital outlays for the coming year. What will the dividend be under a residual policy? What would new borrowing be? 6. EOCQ 21) The Heaven Pty Ltd follows a strict residual dividend policy. Its debt/equity ratio is 1. a) If earnings for the year are $600,000, what is the maximum amount of capital spending possible with no new equity? b) If planned investment outlays for the coming year are $1.5 million, will Heaven pay a dividend? If so, how much? c) Does the Heaven Corporation maintain a constant dividend payout? Why or why not?

17

TUTORIAL 11
CHAPTER 18: DIVIDENDS AND DIVIDEND POLICY 1. CQ 18.7a) Would a shareholder prefer an on-market buy-back or a fully-franked extra cash dividend? 2. EOCQ 25) Jan Town, the manager of Grow Corporation, is deciding whether to pay out $50 million in excess cash in the form of an extra dividend or make a share repurchase. Current earnings are 25 cents per share, and shares sell for $2.50 each. Market value statistics before paying out the $50 million are: Excess cash $50 million Other assets $250 million Total assets $300 million Debt $50 million Equity $250 million Total $300 million Jan is worried about the effect of the alternatives on the price per share, the EPS and the P/E ratio. Show her what the effect will be.

CHAPTER 21: MERGERS, ACQUISITIONS AND TAKEOVERS 3. CQ 21.4a) What are the relevant incremental cash flows for evaluating a merger candidate? 4. CQ 21.6b) What are some important factors in deciding whether to use shares or cash in an acquisition? 5. EOCQ 6) Gems Pty Ltd is analysing the possible acquisition of Vida Ltd. Both firms have no debt. The forecast of Gems shows that the purchase would increase its annual total after-tax cash flow by $880 000 indefinitely. The current market value of Vida is $10 million, and that of Gems is $16 million. The appropriate discount rate for the incremental cash flow is 11 per cent. Gems is trying to decide whether it should offer 40 per cent of its shares or $12 million in cash to Vida. a) What is the cost of each alternative? b) What is the NPV of each alternative? c) Which alternative should Gems choose?

18

6. EOCQ 8) This is a moderate challenge problem. Hammer Hardware Ltd is considering making an offer to purchase Head Industries Ltd. The financial manager has collected the following information: Hammer Head Price/earnings ratio 16 14 Number of shares 10 000 000 250 0000 Eearnings $1 000 000 $750 000 She also knows that securities analysts expect the earnings and dividends (currently $0.18 per share) of Head to grow at a constant rate of 5 per cent each year. Her research tells her, however, that the acquisition would provide Head with some economies of scale that would improve this growth rate to 7 per cent per year. a) What is the value of Head to Hammer? b) What would Hammers gain be from this acquisition? c) If Hammer offers $4.50 in cash for each outstanding share of Head, what would the NPV of the acquisition be? d) If, instead, Hammer were to offer 6,000,000 of its shares in exchange for the outstanding shares of Head, what would the NPV be? e) Should the acquisition be attempted, and, if so, should it be a cash or share offer? f) Hammers management thinks that 7% growth is too optimistic and that 6% is more realistic. How does this change your previous answers?

19