Question

In: Finance

merger and acquisition Firm Z has a current market value of $35 million and is considering...

merger and acquisition

Firm Z has a current market value of $35 million and is considering the acquisition of firm Y, whose current market value is $20 million. Both firms are all-equity. A market research study by the investment bank hired by firm Z shows that a purchase of firm Y will increase the after-tax cash flows of Y by $600,000 in perpetuity. The appropriate discount rate for the incremental cash flow is 8%. a) What is the value of firm Y to firm Z? b) Firm Z is trying to decide whether to offer 25% of its own stocks or $21 million cash to shareholders of firm Y. If you were a shareholder of firm Z, which method of payment would you prefer for the acquisition of firm Y and why?

Solutions

Expert Solution

a) Current market value of Z = $35 million and Current market value of Y = $20 million

Incremental after cash flow for firm Y due acquisition = $600000, Discount rate = 8%

Value of Y to Z will be equal to sum of current market value of Y and present value of incremental cash flows of Y due to acquisition

Value of firm Y to firm Z = Current market value of Y + Present value of incremental after tax cash flow of firm Y discounted at 8%

We know that present value of a perpetuity = Cash flow / Discount rate

So Value of firm Y to firm Z = $20 million + (600000 / 8%) = 20 million + 7500000 = 20 million + 7.5 million = $27.5 million

b)

Value of combined firm Y and Z = Current market value of Y + Current market value of Z + Present value of incremental after tax cash flow of firm Y discounted at 8% = 20 + 35 + 7.5 = $62.5 million

Synergy of merger to Z = Value of combined firm - Sum of current market value of firm Y & Z = 62.5 - (20+35) = 62.5 - 55 = 7.5 million

To compare both the offers we need find the NPV of both the offers

Finding NPV for cash offer

Premium of cash offer = Cash paid or cost of offer - Current market value of firm Y = 21 - 20 = 1 million   

NPV of merger to firm Z = Synergy - Premium of cash offer = 7.5 - 1 = $6.5 million

Finding NPV of Stock offer

Cost of stock offer = Percentage of stock offered of firm Z to firm Y x Value of combined firm = 25% x 62.5 = 15.625 milloin

Hence Firm Z will offer shares worth $15.625 million to Y

Premium of stock offer = Cost of stock offer - Current market value firm Y = 15.625 - 20 = - 4.375 million

NPV of stock offer = Synergy - Premium of stock offer = 7.5 - (-4.375) = 7.5 + 4.375 = 11.875 million

Since NPV of stock offer is greater than that of cash offer, hence Stock offer should be preferred for acquisition.


Related Solutions

Firm A is considering a merger with Firm B. The current market value of A is...
Firm A is considering a merger with Firm B. The current market value of A is $20,000,000 and the volatility of asset return is 58% percent. A also has a zero coupon bond with a face value of $8,000,000 that matures in 3 years. B’s market value is $9,000,000 with standard deviation of asset return of 70% and a zero coupon bond of $3,000,000 that matures in 3 years. The continuously compounded risk free rate is 4%. After the merger...
Firm A is considering a merger/acquisition with Firm B. Firm A: Market value of debt: $2...
Firm A is considering a merger/acquisition with Firm B. Firm A: Market value of debt: $2 million Market value of equity: $4 million Number of shares: 200,000 Firm B: Market value of debt: $5 million Market value of equity: $5 million Number of shares: 500,000 Investment rate for the combined firm (bA+B): 70% WACC for the combined firm (WACCA+B): 10% Total net operating income before synergy gain: (X): $3 million Synergy rate (a): 15% Corporate tax rate (T): 40% Growth...
KMS Corporation has assets with a market value of $471 million, $35 million of which are...
KMS Corporation has assets with a market value of $471 million, $35 million of which are cash. It has debt of $290 million, and 12 million shares outstanding. Assume perfect capital markets. a. What is its current stock price? current price is 15.08 b. If KMS distributes $35 million as a dividend, what will its share price be after the dividend is paid? dividend paid is 12.17 c. If instead, KMS distributes $35 million as a share repurchase, what will...
Consider a firm that currently has a market value of $2,000,000. The firm is considering a...
Consider a firm that currently has a market value of $2,000,000. The firm is considering a project with the following yearly cash flows and a required return (hurdle rate) of 12%. T=0 -1,500,000 T=1 400,000 T=2 -200,000 T=3 900,000 T=4 700,000 T=5 500,000 a) What is the NPV of the project? b) Calculate the Modified IRR (MIRR) using a 12% discount rate. c) If the firm decided to go forward with (i.e., accept) this project, what would the firm's new...
A firm has 5 million shares outstanding with a market price of $35 per share. The...
A firm has 5 million shares outstanding with a market price of $35 per share. The firm has $15 million in extra cash (short-term investments) that it plans to use in a stock repurchase; the firm has no other financial investments or any debt. What is the firm's value of operations after the repurchase? Enter your answer in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answer to two decimal places....
Currently the firm has total market value of debt $20 million and total market value of...
Currently the firm has total market value of debt $20 million and total market value of equity $60 million. This capital structure is considered optimal by the management. The optimal capital budget for new investment for the coming period is determined to be $15 million. The total net income is estimated to be $20 million. The firm has 5 million common shares outstanding. The most recent dividend per share is $1 and the management intends to maintain it for the...
A firm has current assets that could be sold for their book value of $32 million....
A firm has current assets that could be sold for their book value of $32 million. The book value of its fixed assets is $70 million, but they could be sold for $100 million today. The firm has total debt with a book value of $50 million, but interest rate declines have caused the market value of the debt to increase to $60 million. What is the ratio of the market value of equity to its book value? (Round your...
Discuss the relation between the types of integration and market structure, considering the current merger between...
Discuss the relation between the types of integration and market structure, considering the current merger between Ghana Home Loans and First National Bank of Ghana in the mortgage industry.
You are considering the proposed acquisition of a truck for the firm. The truck has a...
You are considering the proposed acquisition of a truck for the firm. The truck has a base price of Tk. 300,000 and it will take another Tk.50,000 to modify it for the intended use. The truck has a life of 5 years and after that period it can be sold for Tk. 100,000. The use of truck will require an increase in the net operating working capital of Tk. 10,000. The truck will reduce cost by Tk. 55,000 in before...
Firm A has a value of $500 million and Firm B has a value of $300...
Firm A has a value of $500 million and Firm B has a value of $300 million. Firm A has 1000 shares outstanding, and firm B has 1000 shares outstanding. Suppose that the merger would increase cash flows of the combined firm by $5 million in perpetuity. Assuming the cost of capital for the firm is 10% Suppose that instead of paying cash, Firm A acquires B by offering two (new) shares of A for every three shares of B....
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT