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CHAPTER 18

SOLUTIONS TO PROBLEMS: P18-4, 18-5, 18-8, 18-11, 18-12

P18-4. Asset acquisition decision

LG 3; Challenge
a.
n
CFt
NPV = – CF
(1 + r)t
t=1

Effective cost of press:  $75,000 + $90,000 − $62,500 = $102,500

25,000 1
NPV = -102,500+ × 1- = $35,911
. 125 (1+.125)

b. Plumbing Company should merge with Bathroom Goodies because the NPV is greater than zero.
c.
Purchase press:  $110,000

30,000 1
NPV = -110,000+ × 1- = $56,093
. 125 (1+.125)

Because the net present value of the new assets exceeds the net present value of the cost of
acquiring Bathroom Goodies, Plumbing Company should purchase the new assets instead of
acquiring Bathroom Goodies. The advantage of getting better quality from the assets would have
to be considered on a subjective basis.

P18-5. Cash acquisition decision

LG 3; Challenge
CFt
a. NPV = ∑nt=1 – CF
(1 + r)t

Year Cash Flows PV of Cash Flows (13.5%)

1–5 $45,000 $ 156,363.42
6–10 $90,000 166,029.73
Total present value of cash inflows $322,393.15
Less: cost of acquisition 250,000.00
NPV $ 72,393.15

Because the NPV is positive, the acquisition is recommended. If interest rates will further
increase, then the decision needs to be re-evaluated.

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b.
52,000 1
NPV = -250,000+ × 1- = $69,517.49
. 10 (1+.10)
The acquisition should be made as NPV of cash flows from the acquisition exceeds the NPV of
cash inflows from the equipment purchase
c.
Year Cash Flows PV of Cash Flows (10%)
1–5 $45,000 $ 170,585.40
6–10 $90,000 211,840.23
Total present value of cash inflows $382,425.63
Less: cost of acquisition 250,000.00
NPV $ 132,425.63

At 10% cost of capital the net present value (NPV) of the acquisition is $132,425.63, and at
13.5% cost of capital the NPV of the acquisition is $72,393.15. Both are greater than the NPV of
the equipment purchase at the 10% cost of capital. If the cost of capital did not change and
remained at 10%, then the company should still make the acquisition.

P18-8. EPS and merger terms

LG 3; Challenge
a. 120,000  0.6 = 72,000 new shares to be issued
b. ($2,200,000  $1,000,000) ÷ (200,000  72,000) = $11.76 per share
c. $11.76  0.6 = $7.05 per share
d. $11.76  $11.00 = $0.76

P18-11. EPS and postmerger price

LG 3; Challenge
a.
MPacquiring × RE
MRP =
MPtarget

Market price ratio of exchange: ($25  1.5) ÷ $30 = 1.25

b. Sheldon Enterprises EPS = $250,000 ÷ 80,000 = $3.13
P/E = $25 ÷ $3.13 = 7.99 times
Weldon Enterprises EPS = $75,000 ÷ 25,000 = $3.00
P/E = $30 ÷ $3.00 = 10 times
c. Price paid per share= ratio of exchange × market price of acquirer
= 1.5  $25 = $37.50
P/E = $37.50 / 3.00 = 12.5 times
d. New shares issued = 1.5  25,000 = 37,500
Total shares = 37,500  80,000 = 117,500
EPS = ($250,000  $75,000) ÷ 117,500 = $2.77
e. New market price = new EPS × P/E
= $2.77  7.99 = $22.13
The market price decreases due to the lower P/E ratio of Sheldon Enterprises and the fact that the
P/E ratio is not expected to change as a result of the acquisition.

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P18-12. Holding company

LG 4; Challenge
a. Total assets controlled: $35,000  ($500,000  $900,000)  2.5%
b. Outside company’s equity ownership:
$5,250  ($500,000  $900,000)  0.375%
c. By gaining voting control in a company for a small investment, then using that company to gain
voting control in another, a holding company provides control for a relatively small investment.
The use of debt financing is critical.
d. (1) Total assets controlled:
$35,000  ($500,000  $900,000  $400,000  $50,000  $300,000 
  $400,000)  1.37%
(2) Outside company’s equity ownership: 0.15  1.37%  0.206%

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