Exercise: Merge and Acquisition

1. Holmes, Inc., has offered $295 million cash for all of the common stock in Watson
Corporation. Based on recent market information, Watson is worth $278 million as an
independent operation. If the merger makes economic sense for Holmes, what is the
minimum estimated value of the synergistic benefits from the merger?

Answer: 17 million

2. Consider the following premerger information about firm X and firm Y:

Firm X Firm Y
Total earnings $105,000 $48,300

Shares outstanding 43,900 33,000

Per share values:
Market $53 $19
Book 21 $9

Assume that Firm X acquires Firm Y by paying cash for all the shares outstanding at a
merger premium of $5 per share. Assuming that neither firm has any debt before or after
the merger, construct the postmerger balance sheet for Firm X assuming the use of the
purchase accounting method.

Answer:

Asset from X (book value) $ 921,900

Asset from Y (market value) $ 627,000
Purchase price of Y $ 792,000
Goodwill $ 165,000
Total assets XY = Total equity XY $ 1,713,900

3/ Assume that the following balance sheets are stated at book value. Suppose that Jurion Co.
purchases James, Inc. Then suppose the fair market value of James’s fixed assets is
$23,000 versus the $13,300 book value shown. Jurion pays $30,400 for James and
raises the needed funds through an issue of longterm debt. Construct the postmerger
balance sheet under the purchase method of accounting.
Answer:
CA: 32,200 CL: 7,700
NFA: 72,000 LTD: 44,200
Goodwill: 2.200 Equity: 54,500
Total: 106,400 Total: 106,400

4/ Penn Corp. is analyzing the possible acquisition of Teller Company. Both firms have no debt.
Penn believes the acquisition will increase its total aftertax annual cash flow by $1.3 million
indefinitely. The current market value of Teller is $27 million, and that of Penn is $62
million. The appropriate discount rate for the incremental cash flows is 11 percent. Penn is
trying to decide whether it should offer 35 percent of its stock or $37 million in cash to
Teller’s shareholders.
a. What is the cost of each alternative?
b. What is the NPV of each alternative?
c. Which alternative should Penn choose?

Answer:
a. V* $38,818,182
Cash cost $37,000,000
Equity cost $435,286,364
b. NPV cash $1,818,182
c. NPV stock $3,531,818
d. Acquire the company for stock.
5/ The shareholders of Flannery Company have voted in favor of a buyout offer from Stultz
Corporation. Information about each firm is given below. Flannery’s shareholders will
receive one share of Stultz stock for every three shares they hold in Flannery.
a. What will the EPS of Stultz be after the merger? What will the PE ratio be if the NPV of the
acquisition is zero?
b. What must Stultz feel is the value of the synergy between these two firms? Explain how your
answer can be reconciled with the decision to go ahead with the takeover.

Answer:
a. EPS $5.401
The market price will remain unchanged since it is a zero NPV acquisition.
Current share price = $60.02
New P/E= 11.11

b. V* $1,460,500
Cost= $1,460,500
V= $0

6/ Firm A does well in a boom economy. Firm B does well in a bust economy. The
probability of a boom is 50%. The end of period values of the two firms depend on the
economy as shown below:

Economy Probability Value of A Value of B

Boom .5 $1,600 800
Bust .5 800 2,000
Expected Value $1,200 $1,400

Both firms have debt outstanding with a face value of $1,000. In order to diversify, the two
firms have proposed a merger. The NPV of the merger is zero. Determine the gain or loss
under each state of economy for the stockholders of A and B separately and for the
combined firm AB. Should either the stockholders or bondholders be willing to support the
merger (prove and state why)?

Answer:
Payoff to shareholders Boom Bust
A 600 0.00
B 0 1,000
AB 400 800
Loss to shareholders of A = 200 of B = 200

Neither shareholders will want to support the merger but bondholders would as their
risk is lower and potential gain under a bust is $200.00.

7/ Firms A and B, both of which are 100% equity, are going to merge. Before the
merger, Firm A (100 shares outstanding) is worth $15,000. Firm B (50 shares
outstanding) is worth $10,000. The combined firm is worth $30,000. Firm A will pay
$11,500 in cash for Firm B. What is the NPV of the merger to Firm A?

Answer:
Synergy = $30,000 – 15,000 – 10,000 = 5,000
NPV = Synergy - Premium = $5,000 – 1,500 = $3,500.
Value of Firm A After the Acquisition: $30,000 – 11,500 = $18,500
NPV to Firm A = $18,500 – 15,000 = $3,500

8/ Dexter Department Stores has a market value of $400 million and 20 million shares
outstanding. Walnut Stores has a market value of $134 million and 13.4 million
shares outstanding. Dexter is deciding to acquire Walnut Stores. The top management
of Dexter's have determined that due to the synergies between the firms the
combination will worth $667 million. Dexter expect to pay a $67 million premium for
Walnut Stores.
If Dexter offers 10 million shares in exchange for the 13.4 million shares of Walnut,
what will the exchange ratio and the equivalent cash value?

Answer:
Market Value exchange ratio = 1.49:1
Share exchange ratio = 0.746

9/ Dexter Department Stores has a market value of $400 million and 20 million shares
outstanding. Walnut Stores has a market value of $134 million and 13.4 million
shares outstanding. Dexter is deciding to acquire Walnut Stores. The top management
of Dexter's have determined that due to the synergies between the firms the
combination will worth $667 million. Dexter expect to pay a $67 million premium for
Walnut Stores.
If Dexter offers 10 million shares in exchange for the 13.4 million shares of Walnut,
what will the after acquisition stock price of Dexter be?

Answer:
Price = Total Value/Total # of shares = 667/(20 + 10) = 667/30 = 22.23.