Question

Fly-By-Night Couriers is analyzing the possible acquisition of Flash-in-the-Pan restaurants. Neither firm has debt. The forecasts of Fly-By-Night show that the purchase would increase its annual after-tax cash flow by $600,000 indefinitely. The current market value of Flash-in-the-Pan is $20 million. The current market value of Fly-By-Night is $35 million. The appropriate cost of capital for the incremental cash flows is 8 percent.

1. What is the synergy form the merger?

2. What is the GAIN from the merger?

Fly-By-Night is trying to decide whether it should offer 25 percent of its stock OR $15 million in cash to Flash-in-the-Pan.

3. What is the cost to Fly-By-Night of each alternative?

4. What is the NPV to Fly-By-Night of each alternative?

5. Which alternative should Fly-By-Night use?

6. Which alternative should Fly-By-Night use?

Answer 1

(1) Synergy From merger = Prsent value of annual incremental  after-tax cash flow by

=>Synergy From merger= $600,000/8% = $7500000 or $7.5 Million

(2)

Gain from the merger = Market value of Flash-in-the-Pan + Synergy benefit - Consideration paid.

Under cash Alternetive Gain from the merger= $20 million+$7.5 Million- $15 Million

=>Under cash Alternetive Gain from the merger = $12.5 Million

Under Stock Alternative, gain from mereger = $20 million+$7.5 Million- $15.625 Million=$11.875 Million

(3)

cost to Fly-By-Night under cash alternative = $15 Million

Value of the Merged firm = value of Fly-By-Night+value of Flash-in-the-Pan+Synergy From merger

=>Value of the Merged firm=$35 million+$20 million+$7.5 Million = $62.5 Million

cost to Fly-By-Night under Stock alternative = 25% * $62.5 Million = $15.625 Million

(4)

value of Flash-in-the-Pan to Fly-By-Night = current market value of Flash-in-the-Pan+ Synergy From merger

=>value of Flash-in-the-Pan to Fly-By-Night=$20 million+$7.5 Million = $27.5 Million.

NPV to Fly-By-Night of cash alternative = value of Flash-in-the-Pan to Flyby night - Cash payment

=>NPV to Fly-By-Night of cash alternative=$27.5 Million- $15 Million = $12.5 Million

NPV to Fly-By-Night of stock alternative = value of Flash-in-the-Pan to Flyby night - Fair value of stock

=>NPV to Fly-By-Night of stock alternative=$27.5 Million-$15.625 Million = $11.875 Million

(5&6) Use cash alternatives as it has Higher NPV.