Question

1. Bloom Corp. is evaluating the possible acquisition of Tulip Inc. at the end of 2019. After the merger, Bloom expects to operate Tulip as a wholly-owned subsidiary of Bloom. Bloom’s analysts have estimated the following information for Tulip as a stand-alone entity and if it becomes part of Bloom (this incorporates the impact of synergies expected from the merger). The risk-free rate is 5.5% and the market risk premium is 4.5%. Tulip Inc. has 120,000 shares of stock outstanding.

Stand-alone Tulip Inc. Data                                                                                  2020

Sales	$ 600,000
Cost of Goods Sold	$ 390,000
Selling & Administrative Expenses	$ 68,000
Interest Expense	$ 52,000
Depreciation	$ 40,000
Cash flow plow-back	$ 14,000
Beta	1.2
Growth in FCFE beyond 2020	4.4% per year forever
Tax Rate	34%
Tulip Subsidiary Projections after Merger	2020
Sales	$ 700,000
Cost of Goods Sold	$ 400,000
Selling & Administrative Expenses	$ 72,000
Interest Expense	$ 74,000
Depreciation	$ 50,000
Cash flow plow-back	$ 26,000
Modified Beta	1.28
Growth in FCFE beyond 2020	4.8% per year forever
Tax Rate	40%

1. Estimate the per share stock price of stand-alone Tulip Inc. as of year-end 2019.
2. As of year-end 2019, what is the merger value of Tulip Inc. to Bloom Corp. (on a per share basis)?
3. If Bloom offers a price of $10.25 for each share of Tulip, what is the NPV of the acquisition to Bloom Corp? To Tulip Inc.?

Answer 1

Part (a)

Please see the table below. Last line highlighted in yellow is your answer. Linkage column will help you understand the mathematics.

Stand-alone                                                               2020	Linkage	2020
Sales	A	$600,000
Cost of Goods Sold	B	$390,000
Selling & Administrative Expenses	C	$68,000
Interest Expense	D	$52,000
Depreciation	E	$40,000
Earnings before taxes	F = A - B - C - D - E	$50,000
Tax Rate	G	34%
Taxes	H = F x G	$17,000
Net income	I = F - H	$33,000
Cash flow plow-back	J	$14,000
FCFE	K = I - J	$59,000
Beta	L	1.2
Risk free rate	M	5.50%
Market risk premium	N	4.50%
Cost of equity	O = M + L x N	10.90%
Growth in FCFE beyond 2020	P	4.40%
Equity Value	Q = K / (O - P)	$907,692
Number of shares	R	120,000
Per share price	S = Q / R	$7.56

Part (b)

Last line is your answer

Tulip Subsidiary	Linkage	2020
Sales	A	$700,000
Cost of Goods Sold	B	$400,000
Selling & Administrative Expenses	C	$72,000
Interest Expense	D	$74,000
Depreciation	E	$50,000
Earnings before taxes	F = A - B - C - D - E	$104,000
Tax Rate	G	40%
Taxes	H = F x G	$41,600
Net income	I = F - H	$62,400
Cash flow plow-back	J	$26,000
FCFE	K = I - J	$86,400
Beta	L	1.28
Risk free rate	M	5.50%
Market risk premium	N	4.50%
Cost of equity	O = M + L x N	11.26%
Growth in FCFE beyond 2020	P	4.80%
Equity Value	Q = K / (O - P)	$1,337,461
Number of shares	R	120,000
Per share price = the merger value of Tulip Inc. to Bloom Corp. (on a per share basis)	S = Q / R	$11.15

Part (c)

NPV to Bloom Corp = (11.15 - 10.25) x number of shares = (11.15 - 10.25) x 120,000 = $ 107,461

NPV to Tulip Inc = (10.25 - 7.56) x number of shares = (10.25 - 7.56) x 120,000 = $ 322,308