Assignment #4 – 10 marks Question 1 Although its own operations have shown no growth over the past decade, Hammerworks Inc. has built up a significant cash balance ($2.9 billion) in anticipation of a...

Homework assignment attached


Assignment #4 – 10 marks Question 1 Although its own operations have shown no growth over the past decade, Hammerworks Inc. has built up a significant cash balance ($2.9 billion) in anticipation of a collapse in equity prices which it believes will create opportunities for valuable acquisitions. Following just such a correction, two potential targets are now being considered: Metallion has a current market capitalization of $1.1 billion, $550 million in 6% debt (YTM also 6%), and generates EBIT of $175 million annually with no growth (a 7.1% profit margin on annual sales of $1.4 billion). Goblikon has an enterprise value of $1.3 billion, a market valued D/E of 1.1, and has been growing its profits at 4% for the past several years (it currently has a P/E ratio of 10). In either case, Hammerworks would be expected to pay off the target’s bond holders in full as there is a change of control clause in their bond indentures. Since either acquisition would be paid for with cash, the firm expects that either acquisition would increase EPS. All three firms face a tax rate of 30%, and Hammerworks’ cost of equity is 8%. Assume there are no synergies from either acquisition but that a 10% premium would have to be paid above the market value of their shares. a) Which of the two targets would provide the largest increase in EPS? (2 marks) b) If the two targets are currently fairly valued in an efficient market, which of the two transactions would have the greatest impact on Hammerworks’ enterprise value? Explain. (2 marks) c) What is a “change of control clause” and why would bond holders demand to be paid up in full if the event was triggered? (1 mark) – a bit of outside research may be required d) “Either transaction is an opportunity for Hammerworks to turn cash into increased EPS, which will boost the market value of its shares. By bringing either target under its management, it unlocks substantial value for shareholders concerned about the leveraged capital structure of the targets. Also, since investors pay a premium for effective corporate governance and Hammerworks is widely deemed to have better control systems than either target, their P/E ratios should rise to match its own.” Explain what is wrong with this statement. (3 marks) e) In the absence of synergies, could either transaction be profitable for Hammerworks? Explain why or why not. (2 marks)