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Unformatted text preview: 2 – .11)/(.01) NPV = –$3,023,592 The breakeven credit price is: P(1 + r)/(1 – π ) = $90(1.01)/(.89) P = $102.13 This implies that the breakeven discount is: Breakeven discount = 1 ($90/$102.13) Breakeven discount = .1188 or 11.88% The NPV at this discount rate is: NPV = –3,300($90) + (3,300)($102.13)(.1188 – .11)/(.01) NPV ≈ 0 3. a. The cost of the credit policy switch is the quantity sold times the variable cost. The cash inflow is the price times the quantity sold, times one minus the default rate. This is a onetime, lump sum, so we need to discount this value one period. Doing so, we find the NPV is: NPV = –15($760) + (1 – .2)(15)($1,140)/1.02 NPV = $2,011.76 The order should be taken since the NPV is positive. b. To find the breakeven default rate, π , we just need to set the NPV equal to zero and solve for the breakeven default rate. Doing so, we get: NPV = 0 = –15($760) + (1 – π )(15)($1,140)/1.02 π = .3200 or 32.00% c. Effectively, the cash discount is: Cash discount = ($1,140 – 1,090)/$1,140 Cash discount = .0439 or 4.39% Since the discount rate is less than the default rate, credit should not be granted. The firm would be better off taking the $1,090 upfront than taking an 80% chance of making $1,140. 536 4. a. The cash discount is: Cash discount = ($75 – 71)/$75 Cash discount = .0533 or 5.33% The default probability is one minus the probability of payment, or: Default probability = 1 – .90 Default probability = .10 Since the default probability is greater than the cash discount, credit should not be granted; the NPV of doing so is negative. b. Due to the increase in both quantity sold and credit price when credit is granted, an additional incremental cost is incurred of: Additional cost = (6,200)($33 – 32) + (6,900 – 6,200)($33) Additional cost = $29,300 The breakeven price under these assumptions is: NPV = 0 = –$29,300 – (6,200)($71) + {6,900[(1 – .10)P′ – $33] – 6,200($71 – 32)}/(1.00753 – 1) NPV = –$34,100 – 440,200 + 273,940.31P′ – 10,044,478.08 – 10,666,468.16 $21,185,246.24 = $273,940.31P′ P′ = $77.32 c. The credit report is an additional cost, so we have to include it in our analysis. The NPV when using the credit reports is: NPV = 6,200(32) – .90(6,900)33 – 6,200(71) – 6,900($1.50) + {6,900[0.90(75 – 33) – 1.50] – 6,200(71 – 32)}/(1.00753 – 1) NPV = $198,400 – 204,930 – 440,200 – 10,350 + 384,457.73 NPV = –$74,622.27 The reports should not be purchased and credit should not be granted. 537 5. We can express the old cash flow as: Old cash flow = (P – v)Q And the new cash flow will be: New cash flow = (P – v)(1 – α )Q′ + αQ′ [(1 – π )P′ – v] So, the incremental cash flow is Incremental cash flow = –(P – v)Q + (P – v)(1 – α)Q′ + α Q′ [(1 – π )P′ – v] Incremental cash flow = (P – v)(Q′ – Q) + α Q′ [(1 – π )P′ – P] Thus: (P  v)(Q ′  Q) + αQ ′{(1  π )P ′  P} NPV = (P – v)(Q′ – Q) – αPQ′ + R 538 CHAPTER 29 MERGERS AND ACQUISITIONS
Answers to Concepts Review and Critical Thinking Questions 1. In the purchase method, assets are recorded at market value, and goodwill is created to account for the excess of the purchase price over this recorded value. In the pooling of interests method, the balance sheets of the two firms are simply combined; no goodwill is created. The choice of accounting method has no direct impact on the cash flows of the firms. EPS will probably be lower under the purchase method because reported income is usually lower due to the required amortization of the goodwill created in the purchase. a. False. Although the reasoning seems correct, in general, the new firms do not have monopoly power. This is especially true since many countries have laws limiting mergers when it would create a monopoly. True. When managers act in their own interest, acquisitions are an important control device for shareholders. It appears that some acquisitions and takeovers are the consequence of underlying conflicts between managers and shareholders. False. Even if markets are efficient, the presence of synergy will make the value of the combined firm different from the sum of the values of the separate firms. Incremental cash flows provide the positive NPV of the transaction. False. In an efficient market, traders will value takeovers based on “fundamental factors” regardless of the time horizon. Recall that the evidence as a whole suggests efficiency in the markets. Mergers should be no different. False. The tax effect of an acquisition depends on whether the merger is taxable or nontaxable. In a taxable merger, there are two opposing factors to consider, the capital gains effect and the writeup effect. The net effect is the sum of these two effects. True. Because of the coinsurance effect, wealth might be transferred from the stockholders to the bondholders. Acquisition analysis usually disregards this effect and considers only the total value. 2. b. c. d. e. f. 3. Diversification doesn’t create value in and of itself because diversification reduces unsystematic, not syst...
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 Spring '10
 eshmalwi
 Finance, Corporate Finance

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