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Mergers and Acquisitions Sailor Shipping Ltd is analyzing the possible acquisition of Biscuit Foods Ltd. Neither...

Mergers and Acquisitions

  1. Sailor Shipping Ltd is analyzing the possible acquisition of Biscuit Foods Ltd. Neither firm has debt. The forecasts of Sailor Ltd show that the acquisition might increase the combined annual after-tax cash flow by a further $800,000 in perpetuity. The current market value of Biscuit Ltd is $35 million. The current value of Sailor Ltd is $60 million. The appropriate discount rate for the incremental cash flows is 8 percent. Sailor Ltd is trying to decide whether it would offer 40 percent of its stock or $38 million in cash to Biscuit Ltd.

Required:

  1. What is the synergy from the merger?
  2. What is the value of Biscuit Foods to Sailor Shipping Ltd?
  3. What is the cost to Sailor Shipping Ltd of each funding alternative?
  4. What is the NPV to Sailor Shipping of each alternative?
  5. What alternative should Sailor Shipping Ltd use?

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Answer #2

Part (i)

Value of synegy = PV of 800,000 in perpetuity = C /r = 800,000 / 8% = $ 10,000,000 or $ 10 million

Part (ii)

the value of Biscuit Foods to Sailor Shipping Ltd = Stand alone value + Value of synergy = 35 + 10 = $ 45 million

Part (iii)

Value of the merged entity = stand alone value of Sailor Shipping + Value of Biscuit Foods to Sailor Shipping Ltd = 60 + 45 = $ 105 million

Hence, the cost under stock option = 40% of the value of the merged entity = 40% x 105 = $ 42 million

the cost under cash foption = $ 38 million

Part (iv)

NPV of stock option = - 42 + 45 = $ 3 million

NPV of cash option = - 38 + 45 = $ 7 million

Part (v)

Economically, purely based on NPV calculated above, Sailor shipping should use the cash option as it has higher NPV

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