Question

K, Inc., a U.S.-based MNC, has screened several targets. Based on economic and political considerations, only one eligible target remains in Malaysia. K would like you to value this target and has provided you with the following information: • K expects to keep the target for three years, at which time it expects to sell the firm for 500 million Malaysian ringgit (MYR) after deducting any taxes due. • K expects a strong Malaysian economy. Consequently, the estimates for revenues for the next year are MYR300 million. Revenues are expected to increase by 9 percent over the following two years. • Cost of goods sold is expected to be 60 percent of revenues. • Selling and administrative expenses are expected to be MYR40 million in each of the next three years. • The Malaysian tax rate on the target's earnings is expected to be 30 percent. • Depreciation expenses are expected to be MYR15 million per year for each of the next three years. • The target will need MYR9 million in cash each year to support existing operations. • The target's current stock price is MYR35 per share. The target has 11 million shares outstanding. • Any cash flows remaining after taxes will be remitted by the target to K, Inc. K uses the prevailing exchange rate of the Malaysian ringgit as the expected exchange rate for the next three years. This exchange rate is currently $.23. • K required rate of return on similar projects is 13 percent. a. Based on the information provided above, the net present value of the Malaysian target is how much? Show your work and discuss. b. The Malaysian target's value based on its stock price is how much? Show your work and discuss. c. The target's board has indicated that it finds a premium of 30 percent appropriate. You have been asked to negotiate for K with the Malaysian target. What is the maximum percentage premium you should be willing to offer? Why?

Am Re-submitting because the first answer was wrong

Answer 1

(a) Computation of the net present value of the Malaysian target.We have,

Year	1	2	3
Revenue	300.00	327.00	356.43
Less: COGS(60% of revenue)	180.00	196.20	213.86
Gross Profit	120.00	130.80	142.57
Less: Selling & Administrative expenses	40.00	40.00	40.00
Less: Depreciation expenses	15.00	15.00	15.00
Earnings Before Taxes	65.00	75.80	87.57
Less Tax expense(30%)	19.50	22.74	26.27
Earnings After Taxes	45.50	53.06	61.30
Add: Depreciation expenses	15.00	15.00	15.00
Less: Fund to Reinvest	9.00	9.00	9.00
Sale of Firm	0	0	500
Cash Flows in MYR	51.50	59.06	567.30
Exchange Rate of MYR	$ 0.23	$ 0.23	$ 0.23
Cash Flows in $	11.84	13.58	130.48
PVIF (13% disc. rate)	0.885	0.783	0.693
PV of Cash Flows in $	10.48	10.63	90.42

Net Present Value of Malaysian target to K Inc.= (10.48 + 10.63 + 90.42) = $ 111.52 million

(b) Computation of the Malaysian target's value based on its stock price.We have,

The Malaysian target's value based on its stock price = Market price per share x Number of share outstanding

The Malaysian target's value based on its stock price = MYR 35.00 X 11.00 million = MYR 385 million

The Malaysian target's value based on its stock price in Doller = 385 x 0.23 = $ 88.55 million

(C) Computation of the maximum price demanded by the Target.

30% premium on value based stock price is demanded by Target. Hence,

Total amount demanded by the Target = 88.55 + (88.55 x 30%) = 88.55 + 26.56 = $ 115.12 million

The maximum percentage premium offer to Target = (111.52 - 88.55) / 88.52

The maximum percentage premium offer to Target = 23.00/88.55 = 0.2597*100 = 25.97 %