Based on the premium on a recent comparable transaction, Logan’s best estimate of the takeover premium for Durtech is closest to

Josh Logan is a buy-side equity analyst who follows Durtech. Logan’s supervisor
believes that Durtech is a likely takeover candidate and has asked Logan to estimate the
80 Learning Outcomes, Summary Overview, and Problems
part-i-10 13 January 2012; 10:24:24
company’s value per share in the event of an “all stock” takeover bid. Logan plans to estimate
Durtech’s value per share using three approaches: discounted cash flow, comparable company
analysis, and comparable transaction analysis.
Durtech has 1.2 million common shares outstanding and no outstanding long-term debt
or preferred stock. Logan estimates that Durtech’s free cash flows at the end of the next three
years will be $5.0 million, $6.0 million, and $7.0 million, respectively. After Year 3, he
projects that free cash flow will grow at five percent per year. He determines the appropriate
discount rate for this free cash flow stream is 15 percent per year.
Applying discounted cash flow analysis to the preceding information, Logan determines
that Durtech’s fair enterprise value is $61.8 million. In a separate analysis based on ratios,
Logan estimates that at the end of the third year, Durtech will be worth ten times its yearthree free cash flow.
Logan’s supervisor is troubled by the sensitivity of his enterprise value calculation to the
terminal growth rate assumption. She asks Logan:
“What is the percentage change in your fair enterprise value of $61.8 million if you use a
terminal growth rate of zero percent rather than five percent?”
Logan gathers data on two companies comparable to Durtech: Alphatech and Betatech.
He believes that price-to-earnings, price-to-sales, and price-to-book-value per share of these
companies should be used to value Durtech. The relevant data for the three companies are
given in Exhibit A.
EXHIBIT A Valuation Variables for Durtech
and Comparable Companies
Valuation Variables Alphatech Betatech Durtech
Current stock price ($) 72.00 45.00 24.00
Earnings per share ($) 2.00 1.50 1.00
Sales per share ($) 32.00 22.50 16.00
Book value per share ($) 18.00 10.00 8.00
Logan also identifies one recent takeover transaction and analyzes its takeover premium (the amount by which its takeover price per share exceeds its current stock price).
Omegatech is comparable to the possible transaction on Durtech. Omegatech had a stock
price of $44.40 per share prior to a newspaper report of a takeover rumor. After the
takeover rumor was reported, the price rose immediately to $60.30 per share. Eventually,
the takeover offer was accepted by Omegatech’s shareholders for $55.00 per share. Oneyear trailing earnings per share for Omegatech immediately prior to the takeover were
$1.25 per share.
In order to evaluate the risk of government antitrust action, Logan computes the
Herfindahl–Hirschman Index (HHI) for the industry group that includes Durtech.
He computes the pre-merger value of the HHI to be 1400. As shown in Exhibit B, Logan
also computes the post-merger industry HHI assuming three possible merger scenarios with
Durtech.
Chapter 10 Mergers and Acquisitions 81
part-i-10 13 January 2012; 10:24:24
EXHIBIT B Post-Merger Industry HHI (assuming merger
with Durtech)
Durtech Merger Partner Post-Merger Industry HHI
Alphatech 1500
Betatech 1510
Gammatech 1520
Based on this analysis, Logan concludes that the industry is moderately concentrated and
that a merger of Durtech (with any of the companies listed in Exhibit B) will face a possible
government challenge.
A. 19.9%.
B. 23.9%.
C. 35.8%.

Answer: B. 23.9%.