Bumpstead Inc. is interested in acquiring Blondies Corp. which it has estimated will generate the following cash flows over the next three years ($000) In addition, Bumpstead thinks there will be $25,000 per year in synergies available at no extra cost. Blondies has 50,000 shares outstanding, and its cost of equity is approximately 14%. If Bumpstead is very conservative, and will not look beyond a three year time horizon to justify an acquisition, how much should it pay per share for Blondies stock?

A) $21.95
B) $20.79
C) $23.84
D) None of the above

Question

Bumpstead Inc. is interested in acquiring Blondies Corp. which it has estimated will generate the following cash flows over the next three years ($000)

In addition, Bumpstead thinks there will be $25,000 per year in synergies available at no extra cost. Blondies has 50,000 shares outstanding, and its cost of equity is approximately 14%. If Bumpstead is very conservative, and will not look beyond a three year time horizon to justify an acquisition, how much should it pay per share for Blondies stock?

A) $21.95
B) $20.79
C) $23.84
D) None of the above

Hippo Gaming · Accepted Answer

Final Answer : A, Explanation :  To calculate the value of Blondies Corp., we first need to calculate the present value of the cash flows and the synergies.Year 1:Cash flow = $1,500Synergy = $25,000Total = $26,500Present value at 14% = $23,246.85Year 2:Cash flow = $2,500Synergy = $25,000Total = $27,500Present value at 14% = $20,214.79Year 3:Cash flow = $3,500Synergy = $25,000Total = $28,500Present value at 14% = $17,422.15Total present value of cash flows and synergies = $60,883.79To calculate the price per share, we divide the total value by the number of shares outstanding:$60,883.79 / 50,000 = $1.2176758Therefore, Bumpstead should pay $21.95 per share for Blondies stock (rounded to the nearest cent).The correct answer is A.

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