Pampa RV, Inc. is considering the acquisition of Chico Clothing Company (CCC) for a price of $12 per share. Pampa’s has 500,000 shares of common stock outstanding, currently trading at $9.75 per share. The book value of the common stock is $5 per share. Pampa also has bonds with a market value of $3,500,000 and a yield to maturity of 3.4%. Based on current market valuations, Pampa is currently achieving its target debt to equity ratio. Pampa’s equity beta is 0.80.
CCC’s cost of goods sold (COGS) is expected to be 38% of sales revenues, and selling, general and administrative (SG&A) expenses are expected to be 12% of revenues. The firm is 100% equity financed and has 100,000 shares of common stock outstanding. Its equity beta is estimated to be 1.353.
CCC has experienced rapid growth over the last ten years. However, your analysis of industry structure suggests that competition in the beauty pageant clothing and accessories market is likely to increase in the next few years. Thus, you forecast that the perpetual growth rate for free cash flows after five years will be a modest 1.5% per year. The corporate tax rate is 40% for all firms.
| Table 1: Forecast Data for Chico Clothing Company Year | |||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |||
| Sales Revenue | 300,000 | 335,000 | 375,000 | 410,000 | 575,000 | ||
| Investment in CapEx and NWC | 18,000 | 25,000 | 40,000 | 50,000 | 65,000 | ||
| 15,000 | 30,000 | 40,000 | 52,000 | 60,000 | |||
| Depreciation | |||||||
| Table 2 Market Data Current yield to maturity on 30 year treasury bonds | 2.50% |
| Estimate of expected average return on the S&P 500 over the next 30 years | 7.50% |
Suppose Pampa RV offers to pay $12 for each of CCC’s outstanding shares. If the market fully impounds this information, what will be the new price per share of Pampa’s common stock?
