Gulf Oil Corp. – Takeover
Executive Summary
Given the facts in the information provided, we do not feel that an offer of more than $64.17 per share is justified. We recommend that management still submit this bid even though it will probably be rejected. Gulf Oil may be forced to accept a bid lower than $70 per share in the event financing falls through for competitors or other unforeseeable circumstances evolve, such as regulation by FTC. The numbers presented below are reliant upon estimates, which makes the findings highly sensitive to changes in the economic environment. For example, if average inflation over the life of the project is 5.8%, then the resulting savings would justify a bid of $70.10 per share. In addition, using 1983 performance would justify a bid of $70.64 per share. The following table shows how inflation rate changes affect analysis.
|Savings per Share |$27.10 |$21.17 |$13.36 |
|Inflation Rate |5.80% |8.37% |10.00% |
In light of this, we recommend that management review the facts and assumptions and ask the following questions. Are there benefits to the merger not captured in our figures? How does the merger affect the competitive advantage of Socal’s competitors?
Return on Equity
We initially determined that the required rate of return on equity (rE) for Gulf was 6.48%, using the CAPM formula. We assume that the company’s Beta (β) remains 1.15, which we feel is fair given no information that suggests it will change. In addition, we used the current long-term Treasury yield of 12% as the risk free rate (rf) and estimated the market return using average S&P 500 returns from 1976 to 1983. The following table shows how we arrived at rM of 7.20%.
|Year |Standard & |Return |
| |Poor's 500 |
Given the facts in the information provided, we do not feel that an offer of more than $64.17 per share is justified. We recommend that management still submit this bid even though it will probably be rejected. Gulf Oil may be forced to accept a bid lower than $70 per share in the event financing falls through for competitors or other unforeseeable circumstances evolve, such as regulation by FTC. The numbers presented below are reliant upon estimates, which makes the findings highly sensitive to changes in the economic environment. For example, if average inflation over the life of the project is 5.8%, then the resulting savings would justify a bid of $70.10 per share. In addition, using 1983 performance would justify a bid of $70.64 per share. The following table shows how inflation rate changes affect analysis.
|Savings per Share |$27.10 |$21.17 |$13.36 |
|Inflation Rate |5.80% |8.37% |10.00% |
In light of this, we recommend that management review the facts and assumptions and ask the following questions. Are there benefits to the merger not captured in our figures? How does the merger affect the competitive advantage of Socal’s competitors?
Return on Equity
We initially determined that the required rate of return on equity (rE) for Gulf was 6.48%, using the CAPM formula. We assume that the company’s Beta (β) remains 1.15, which we feel is fair given no information that suggests it will change. In addition, we used the current long-term Treasury yield of 12% as the risk free rate (rf) and estimated the market return using average S&P 500 returns from 1976 to 1983. The following table shows how we arrived at rM of 7.20%.
|Year |Standard & |Return |
| |Poor's 500 |