Question

Company A has a market value of equity of $2,000 million and 80 million shares outstanding. Company B has a market value of equity of $400 million and 25 million shares outstanding. Company A announces at the beginning of 2019 that is going to acquire Company B.

The projected pre-tax gains in operating income (in millions of $) from the merger are:

	2019	2020	2021	2022	2023
Pre-tax Gains in Operating Income	12	16	28	38	45

The projected pre-tax gains in operating income are expected to grow at 4% after year 2023. The company is using a discount rate of 8% to value the synergies. The marginal corporate tax rate is 35%.

Company A has decided to pay a $300 million premium for Company B. Assume that capital markets are efficient and that there is a 100% probability the deal will be closed.

If Company A were to offer 0.80 share of Company A for each share of company B, by how much the price per share of Company A would change at the time of the announcement of the acquisition?

Answer 1

We find the benefit from the merger:

Terminal Value = Last Cashflow (1+ Growth)/ (Discount Rate - Growth Rate)

Total value of merged entity = Co A Market Value + Co B Market Value + Merger Value

= 2000 + 400 + 586.23

=2986.23

Co A will give 0.8 shares for ever Share of Co B

Hence Number of shares to be given = 0.8*25 = 20 million

Post merger number of shares = Co A shares + Shares given to Co B = 80 + 20 = 100

Hence Co A shares post merger will be valued = Post Merger Value / Post merger number of shares

= 2986.23 / 100 = 29.86

Pre Merger value of Co A shares = 2000 / 80 = 25

Hence after announcement, value of shares will increase by 4.86