Gm's Bid for Hughes

Mini-Case:

GM’s bid for Hughes Aircraft Corporation

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Mini-Case: GM’s bid for Hughes Aircraft

• Set-up of the Case: • In 1985 GM is considering the acquisition of Hughes Aircraft Corporation. • Hughes Aircraft Corporation, currently owned by the Howard Hughes Medical Institute, is essentially a defense contractor. • If GM is successful this will represent the largest industrial merger ever. • GM is competing with Ford and Boeing which are also biding for Hughes Aircraft.

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Mini-Case: GM’s bid for Hughes Aircraft (cont.)

• Hughes Aircraft is a private company: there are no traded shares of Hughes. Therefore GM has no information on Hughes’ equity beta. • The relevant available information from Hughes Aircraft is: – Expected after-tax earnings of $300 million this year. – Expected (nominal) growth rate of cash flows of 4% per year. • Hughes has no debt but, GM has set a Target D/E of 1.0, after the acquisition.

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Mini-Case: GM’s bid for Hughes Aircraft (cont.)

• Other relevant information: – marginal corporate tax rate: 34% – market return: 14% • Some information on GM: – equity beta (E) is 1.2 – with a current debt to equity ratio (D/E) of 0.4. – discount rate for debt (equal to riskless rate): 8% • However the business risk of GM is unlikely to be an appropriate measure for the business risk of Hughes.

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Mini-Case: GM’s bid for Hughes Aircraft (cont.)

• Since Hughes Aircraft is not a traded company GM has no direct information on its risk/beta. • GM’s consultants were able to collect information on two of Hughes’ competitors, which are public companies: Lockheed and Northrop. – Lockheed has a E of 0.90 while Northrop has a E of 0.85 – With regards to their capital structures, Lockheed has a D/E of 0.90 while Northrop has a D/E of 0.70 – The cost of debt for each these two firms is 9.5%

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Mini-Case: GM’s bid for Hughes Aircraft (cont.)

• Questions:

1) Compute your best measure of the NPV(WACC) for this...