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 aftertax cash flow by $350,000 indefinitely. The current market value of Flash-in-the-Pan is $7 million. The current market value of Fly-By-Night is $20 million. The appropriate discount rate for the incremental cash flows is 8 percent. Fly-By-Night is trying to decide whether it should offer 35 percent of its stock or $11 million in cash to Flash-in-the-Pan.

a.	What is the synergy from the merger? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Synergy value

$

b.	What is the value of Flash-in-the-Pan to Fly-By-Night? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Value

$

c.	What is the cost to Fly-By-Night of each alternative? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g., 1,234,567.)

Cost of cash		$
Cost of stock		$

d.	What is the NPV to Fly-By-Night of each alternative? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g., 1,234,567.)

NPV cash	$
NPV stock	$

e.	Which alternative should Fly-By-Night use?
	Stock offer Cash offer

Answer 1

a) Synergy value = Increase in annual after tax cash flows / discount rate = $350,000 / 8% = $4,375,000

b) Value of Flash-in-the-Pan to Fly-By-Night = Market value of Flash-in-the-Pan + Synergy value = $7,000,000 + $4,375,000 = $11,375,000

c) Cost of cash offer = cash to be paid - market value of Flash-in-the-Pan = $11,000,000 - $7,000,000 = $4,000,000

In case of stock offer, the stock to be offered has to be from post - merger firm. Therefore -

Cost of stock offer = Value of post merger firm x % stock to be offerred - market value of Flash-in-the-Pan

Now, Value of post merger firm = Market Value of Fly-By-Night + Market Value of Flash-in-the-Pan + Synergy Value = $20,000,000 + $7,000,000 + $4,375,000 = $31,375,000

Cost of stock offer = $31,375,000 x 35% - $7,000,000 = $3,981,250

d) NPV of cash offer = Synergy Value - Cost of cash offer = $4,375,000 - $4,000,000 = $375,000

NPV of stock offer = Synergy Value - Cost of stock offer = $4,375,000 - $3,981,250 = $393,750

e) Stock offer should be used as NPV is greater in that case.