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QUESTION 18 Firm A has a value of $500 million and Firm B has a value...

QUESTION 18

  1. Firm A has a value of $500 million and Firm B has a value of $300 million. Firm A has 1000 shares outstanding, and Firm B has 800 shares outstanding. Suppose that the merger would increase cash flows of the combined firm by $5 million in perpetuity. Assuming the cost of capital for the new firm is 5%.

    Assume that Firm A purchases Firm B for $330 million. How much do Firm A's shareholders gain from this merger?

    A.

    $30 million
    B.

    $70 million
    C.

    $20 million
    D.

    $15 million
    E.

    None of the above
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Answer #1

Answer : Correct Option is (B.) 70 million

Calculation of Gain to the shareholder of Firm A

Gain to shareholder of Firm A = Synergy Gain + Value of the Firm B - Purchase Consideration Paid

Synerguy Gain = Annual Cash Flow / Discount Rate

= 5 million / 0.05

= 100 million

Value of Firm B = 330 million

Purcahse Consideration Paid = 330 million

Gain to shareholder of Firm A = Synergy Gain + Value of the Firm B - Purchase Consideration Paid

= 100 million + 300 million - 330 million

= 70 million

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