Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

Atakeovermotivatedonlybydiversificationconsiderations
should,byitself,havenoeffectonthecombinedvalueofthe
twofirmsinvolvedin thetakeover whenthetwo firmsare
bothpubliclytradedandwhentheinvestorsinthefirmscan
diversify on their own. Consider the following example.
DaltonMotors,whichisanautomobileparts manufacturing
firmina cyclical business,plans to acquireLube& Auto,
which is an automobile service firm whose business is
noncyclical and high-growth, solely for the diversification
benefit.Thecharacteristicsofthetwofirmsaresummarized
inTable 15.2.

TABLE 15.2 Characteristics of Firms: DaltonMotors and
Lube & Auto

Dalton

Motors

Lube &

Auto

Beta 1.2 0.9

Pretax cost of debt 5% 5%

Tax rate 30% 30%

Debt-to-capital ratio 10% 10%

Revenues ($ millions) $1,000 $500

Operating income (EBIT) ($

millions)

$50 $25

Pretax return on capital 15% 15%

Reinvestment rate 70% 70%

Length of growth period 5 years 5 years

The Treasury bond rate is 4.25 percent and the market
premium is 4 percent. The calculations for the weighted