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

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.

jeff jeffy answered 3 months ago

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