Question

Firm K is planning to buy firm B. The two firms’ separately are worth $30m and...

Firm K is planning to buy firm B. The two firms’ separately are worth $30m and $10m respectively. Merging the two firms will lead to reducing in management and marketing firm of up to $0.7m per year in perpetuity. Firm K can acquire firm B with cash worth 15m or offer B a 50% holding in K. assume a post merge cost of capital is 10% What is the gain from the merger? What is the cost of the cask offer to K What is the benefit of the cash offer to B What is the stock offer to K What is benefit of the stock offer to B What is the NPV of the cash offer? What is the NPV of the stock offer? When should the firm use a stock offer?

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Answer #1

Gain from merger

Value of synergy = Reduction of management and marketing / cost of capital = $0.7 million / 10% = $7 million

Cash offer

Cost of cash offer = Cash to be paid - market value firm B = $15 million - $10 million = $5 million

Benefit of the cash offer = Gain from merger = $7 million

NPV = $7 million - $5 million = $2 million

Stock offer

The 50% holding to be provided is as % of the post merger value of K.

Post merger value of K = Market value of firm K + Market value of firm B + gain from merger = $30 million + $10 million + $7 million = $47 million

Cost of stock offer = Stock to be offered - market value of firm B = $47 million x 50% - $10 million = $13.5 million

Benefit of stock offer = $7 million

NPV = $7 million - $13.5 million = (-)$6.5 million

The firm should use the stock offer only in case the benefit from the merger is $13.5 million or more.

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