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