Question

Velcro Saddles is contemplating the acquisition of Skiers’ Airbags Inc. The values of the two companies as separate entities are $36 million and $18 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $580,000 per year in perpetuity. Velcro Saddles is willing to pay $24 million cash for Skiers’. The opportunity cost of capital is 8%.

a. What is the gain from the merger? (Enter your answer in millions rounded to 2 decimal places.)

b. What is the cost of the cash offer? (Enter your answer in millions.)

c. What is the NPV of the acquisition under the cash offer? (Enter your answer in millions rounded to 2 decimal places.)

Answer 1

Let's first see the value of the combined entity

Value of Velcro Saddles = USD 36 million

Value of Skiers' Airbags = USD 18 million

Total value of the reduction in marketing & admin costs = 580,000/( 0.08) [ Since, the value of the perpetuity is V/r , where V is the perpetual value per year and r is the cost of capital]

1. Total gain from merger is the value of reduced marketing & admin costs = USD 7.25 million

Total cost of the cash offer is the excess value paid over the listed value of Skier's Airbags = USD 24 million - USD 18 million = USD 6 million

2. Cost of cash offer = USD 6 million

Total Value of the merger for Velcro = Total Skier's current value + Total reduction in marketing & admin costs = 18 + 7.25 = 25.25 million

Total Cash to be paid to Skiers = 24 million

3. Total NPV of the cash offer = 25.25 - 24 = USD 1.25 million