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Harrods PLC has a market value of £500 million and 30 million shares outstanding. Selfridge Department Store has market value £180 million and 20 million shares outstanding. Harrods is contemplating acquiring Selfridge. Harrods CFO concludes that the combined firm with synergy will be worth £720 million, and Selfridge can be acquired at a premium of £25 million.

Merger NPV Calculations
Merger NPV Calculations

Merger NPV Calculations

Harrods PLC has a market value of £500 million and 30 million shares outstanding. Selfridge Department Store has market value £180 million and 20 million shares outstanding. Harrods is contemplating acquiring Selfridge. Harrods CFO concludes that the combined firm with synergy will be worth £720 million, and Selfridge can be acquired at a premium of £25 million.

a) If Harrods offers 12 million shares of stock in exchange for the 20 million shares of Selfridge, what will the stock price of Harrods be after the acquisition?
b) What exchange ratio between the two stocks would make the value of stock offer equivalent to a cash offer of £205 million?

Solution Harrods PLC:

[blur]Number of shares after the acquisition = Current number of shares outstanding for the acquiring firm + number of new shares created for the acquisition[/blur]

[blur]Number of shares after acquisition = 30,000,000 + 12,000,000[/blur]

[blur]Number of shares after acquisition = 42,000,000[/blur]

[blur]Share price = value of the combined company /shares outstanding, which will be:[/blur]

[blur]New stock price = £720,000,000 / 42,000,000[/blur]

New stock price = £17.14

  1. Let equal the fraction of ownership for the target shareholders in the new firm. We can set the percentage of ownership in the new firm equal to the value of the cash offer, so:

[blur]a(£720,000,000) = £205,000,000[/blur]

a = .2847 or 28.47%

The ownership percentage of the target firm shareholders in the new firm can be expressed as:

 

[blur]Ownership = New shares issued / (New shares issued + Current shares of acquiring firm) .2847 = New shares issued / (New shares issued + 30,000,000) New shares issued = 11,941,748[/blur]

[blur]Exchange ratio = New shares / Existing shares in target firm[/blur]

[blur]Exchange ratio = 11,941,748 / 20,000,000[/blur]

[blur]Exchange ratio = .5971[/blur]

 

Merger NPV        Fly-By-Night Couriers is analyzing the possible acquisition of Flash-in-the-Pan Restaurants. Neither firm has debt. The forecasts of Fly By-Night show that the purchases would increase its annual after-tax cash flow by $350,000 indefinitely (i.e., in perpetuity). The current market value of Flash-in-the-Pan is $9 million. The current market value of Fly-By-Night is $23 million. The appropriate discount rate for the incremental cash flows is 8 percent. Fly-By-Night is trying to decide whether it should offer 35 percent of its stock or $12 million in cash to Flash-in-the-Pan.

  1. What is the synergy from the merger?
  2. What is the value of Flash-in-the-Pan to Fly-By-Night?
  3. What is the cost to Fly-By-Night of each alternative?
  4. What is the NPV to Fly-By-Night of each alternative?
  5. What alternative should Fly-By-Night use?
  6. a. The synergy will be the present value of the incremental cash flows of the proposed purchase.  Since the cash flows are perpetual, this amount is
  7. The value of Flash-in-the-Pan to Fly-by-Night is the synergy plus the current market value of Flash-in-the-Pan. VB + VAB ; i.e., not only will we get current market value of Flash in Pan but also the synergy

[blur]V = $9,000,000 + $4,375,000 = $13,375,000[/blur]

[blur]V = VB + synergy = VAB - VA[/blur]

[blur]The value of each alternative cost is: Cash alternative = $12,000,000 Stock alternative = 0.35($13,375,000 +$23,000,000) = $12,731,250[/blur]

[blur]Note: this is 35% of the stock in the new combined company VAB = ($4,375,000 +9,000,000 + 23,000,000 = $36,375,000); in a merger, Flash-in-the-Pan goes away and the acquiring company, Fly-by-Night survives; hence the value of the stock in the new Fly-by-Night is worth (36,375,000 = 13,375,000 + 23,000,000)[/blur]

  1. [blur]Since these values are already in PV terms, the NPVs are simply Value - Cost:[/blur]

[blur]NPV of cash alternative = $13,375,000 - $12,000,000 = $1,375,000[/blur]

[blur]NPV of stock alternative = $13,375,000 - $12,731,250  = $643,750[/blur]

  1. Use the cash alternative, because its NPV is greater.

Note: both the stock * cash offers are below the current market value of Flash-in-the-Pan.

[blur]Merger Analysis Astros Appliances is considering a merger with Cowboys Carpet Cleaner Company. Cowboys is a publicly traded company, and its current beta is 1.30. Since Cowboys has been barely profitable, it pays an average of only 20% in taxes. Also, it uses little debt, having a debt ratio of just 25%.

[blur]If the acquisition were made, Astros would operate Cowboys as a separate, wholly owned subsidiary. Astros would pay taxes on a consolidated basis, and the tax rate would therefore increase to 35%. Astros also would increase the debt capitalization in the Cowboys subsidiary to 40% of assets, which would increase its beta to 1.47. Astros’ acquisition department estimates that Cowboys, if acquired, would produce the following net cash flows to Astros’ shareholders (in millions of dollars):

                Year                                       Net Cash Flows (in $ millions)          

[blur]These cash flows include all the acquisition effects. Astros’ cost of equity is 14%; its beta is 1.0, and its cost of debt is 10%. The risk-free rate is 8%.

  1. What discount rate should be used to discount the estimated cash flows? (Hint: Use Astros’ rs to determine the market risk premium since Astros’s beta = 1.0 .)
  2. What is the dollar value of Cowboys to Astros?
  3. Cowboys has 1.2 (1.1) million common shares outstanding. What is the maximum price per share that Astros should offer for Cowboys?

 

  1. a. The appropriate discount rate reflects the riskiness of the cash flows to equity investors.  Thus, it is Cowboys’s cost of equity, adjusted for leverage effects.  Since Astros’ beta = 1, RPM = rM – rRF = 14% – 8% = 6%, then:

rs = rRF + (rM – rRF)b = 8% + (14% – 8%)1.47 = 16.82%

 

  1. The value of Cowboys is $13.96645594 million:
16.8%

 

6.8%

16.8%

6.8%

0         0                1                2                3                4                5

g = 6%

|                 |                 |                 |                 |                 |

´ 1/1.168

1.30           1.60           1.75            2.00            2.10 (2.10 = 2.0 x 1.05)

´ 1/1.1682                           ´ 1/(1.1682)^2     ´ 1/(1.1682)^3

´ 1/1.168

 

1/(1.168)2

1.1128                                                             [blur]     17.7665 = TV = 2.10/(.1682 - .05)[/blur]

´ 1/(1.168)3

1.1724

´ 1/(1.168)4

1.0977

  10.6136                 19.7664974619

´ [blur]1/(1.1682)^4[/blur]

[blur]V = $13.9965 million[/blur]

 

[blur]CF5 = CF4(1.05) = $2.00(1.05) = $2.10.[/blur]

[blur]Value at t4 of CF5 and all subsequent cash flows is:[/blur]

[blur]V4 =  =  = $17.76647619.[/blur]

[blur]Alternatively, input 0, 1.30, 1.60, 1.75, and 19.7665 (2.00 + 19.7665) into the cash flow register, I/YR = 16.82, NPV = ?  NPV = $13.9965.[/blur]

  1. [blur]PMax = V/N = $13.9965/1.1 = $12.42. (to the nearest cent) The maximum that Astros should pay is what the merger is worth to Astros.[/blur]

[blur]If Astros pays exactly what Cowboys is worth, the acquisition has a zero net present value.[/blur]

 

 

Harrods PLC has a market value of £500 million and 30 million shares outstanding. Selfridge Department Store has market value £180 million and 20 million shares outstanding. Harrods is contemplating acquiring Selfridge. Harrods CFO concludes that the combined firm with synergy will be worth £720 million, and Selfridge can be acquired at a premium of £25 million.

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