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EXERCISE GUIDE
CORPORATE FINANCE
MERGERS AND ACQUISITIONS

Problem 1 (M&A)

Assume that company A and company B are debt-free companies, and they have a market value
from $500 and $100, respectively. If company A acquires company B, the merged company
AB will have a combined value of $700, due to synergies of $100. Company B indicated that
I would sell the company for $150 in cash.

a) Should company A acquire company B? Suppose that company A is using

retained earnings for acquisition.

Value of company A after the acquisition = Value AB - cash payment = $700 - $150 = $550
Thus, the VPN of the acquisition (for the shareholders) = $550 - $500 = $50.

If we assume that there are 25 shares of company A before the acquisition, what is the value of
the actions before and after the acquisition?

The value of the shares before the acquisition is $20 (= $500/25)

The value of the shares after the acquisition is $22 (= $550/25).

Company A should proceed with the acquisition as it has a positive NPV.

Company A pays $150 for the acquisition, but only achieves $100 in synergy (= $700 - ($500 + $100)).
$500

Thus, Company A paid a premium over the value of the company of $50.

Thus, the acquisition VPN is = $100 (higher value due to synergy) - $50 (premium over the value of
Company B alone) = $50.

b) Now suppose that the acquisition of B will be made in shares of A and not in
Cash. What stock price of A will be used? $20 or $22?

As company A is considering acquiring company B, the market price of the

The shares of company A will change. To what value?

The value of company A will be between $500 (= value before the merger) and $550 (= value post merger).

Assume there is a 60% probability that the acquisition will take place. Then E(A) = 0.6 x
$550 + 0.4 x $500 = $530. The price of A's shares will be $21.20, not $20.

Now suppose that company A wants to use the shares to make the acquisition of the
company.
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Assume that company B has 10 shares issued. Also assume that company A wants to
exchange 7.5 of its own shares (will issue) for the entire company B, $20 of the
action A versus $10 of the shares of company B. Therefore, the exchange rate is
0.75:1 that is to say company A gives 0.75 of its shares for every 1 share of company B

The value of the stock exchange is 7.5 x $20 = $150 which is incorrect, $20 versus $22.
The true cost of the exchange is greater than $150.

After the acquisition, company A has 32.5 (= 25 + 7.5) shares issued. This implies
23% of the combined company (=7.5/32.5). It is valued at $161 (=0.23x$700). Thus, the cost of
the acquisition is $161, not $150.

Thus, the value of stock A after the acquisition (stock for stock) = $21.54
($700/32.5), compared to $22 per share (cash per share).

The cost of acquisition using shares is higher than using cash.

This is because the exchange rate is 0.75:1, which was based on the price of the A shares before the
acquisition. Given that stock prices rise after the acquisition, the
Company B receives more than $150 in shares of company A.

What should the exchange rate be for stock B to receive only $150 of stock A?

Let the exchange rate be α, then, αx$700=$150 → α=150/700=0.2143.

This means that the shareholders of company B will receive shares that will be worth $150 if they
They obtain 21.43% of the combined company after the merger.

That is α = (newly issued shares) / (old shares + newly issued shares) =

(New shares issued) / (25 + New shares issued)

By substituting the values into the equation, we get:

0.2143 = (New shares issued) / (25 + New shares issued), solving for the
new shares issued, we obtain:

New shares issued = 6,819

Thus, the total number of shares issued after the merger = 31.819 (= 25 + 6.819)

Given that company A will obtain 10 shares of company B for 6.819 shares of the company
A, the exchange rate is 0.6819:1.

The stock price after the merger is $22 (=$700/31.819). Thus, the value of the 6.819
actions is = $22 x 6.819 = $150. This is the same value as in the cash option
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Problem 2 (M&A)

Company W is considering buying company P for $95,000. The current cost of capital
The WACC is 12%. The estimated cost of capital for P after the acquisition will be 10%. The cash flows
Projected cash flow from year 1 to year 8 is $13,000. (Assume there is no residual value)

Would you recommend the acquisition?

The net present value is:

Year Present Value

0 (-$95,000 x 1) = ($95,000)
1-8 ($13,000 x 5.3349) = 69,354

Net Present Value ($25,646)

Using 10% as the discount rate

The acquisition is not advisable as it has a negative present value.

Problem 3 (M&A)

Bishop Company has decided to sell its business for a sale amount of $50,000. The balance
The bishop is the following:

Cash $3,000
Accounts receivable $7,000
Inventory $12,000
Teams - Dyeing $115,000
Equipment - Cutting $35,000
Equipment - Packaging $30,000
Total Assets $202,000
Liabilities $80,000
Heritage $122,000
Total Liabilities & Equity $202,000

Allman Company is interested in acquiring two assets – Dyeing and cutting equipment.
He has considered selling the other assets for $35,000. Allman estimates that the total cash flows
Cash flow futures for the dyeing and cutting team will be $26,000 per year for the next 8 years.
Years. The cost of capital is 10% for the associated free cash flows. Ignore taxes.
Should Allman acquire Bishop for $50,000?

Amount paid to Bishop $ (50,000)

Debt amount $ (80,000)
Less cash on hand $ 3,000
Less Effective Sale of Assets $ 35,000
Initial Cash Amount $ (92,000)
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Present Value of Free Cash Flows for the Next 8 Years

VP (@10%) of Future Cash Flows - $26,000 x 5.3349 $ 138,707
Net Present Value (NPV) $46,707

Based on the result of the NPV, Allman should acquire Bishop for $50,000 given that the
VPN is positive, equivalent to $46,707.

Problem 4 (M&A)

Greer Company has planned to acquire Holt Company by exchanging shares.

Greer will issue 1.5 shares for each share of Holt. Greer expects that the P/E ratio for the
combined company is 15x.

What is the utility per share (UPS) of the combined company? And the expected price of
Greer after the acquisition?

The financial information for the two companies is as follows

Greer Holt
Net Result $ 400,000 $100,000
Issued Shares 200,000 25,000
Earnings per share $2.00 $ 4.00
Market price per share $40.00 $ 48.00

Combined UPA = ($ 400,000 + $ 100,000) / (200,000 shares + (25,000 x

$500,000/237,500 = $2.11

Expected P/U ratio = 15x

Expected stock price = $31.65

Problem 5 (M&A)

Romer Company will acquire all issued shares of Dayton Company through a
share exchange. Romer is offering $65 per share of Dayton.
The financial information of the 2 companies is as follows:

Romer Dayton
Net Result $50,000 $10,000
Issued Shares 5.000 2,000
Earnings Per Share (EPS) $10.00 $5.00
Market price per share $150.00
P/U 15x

a) Calculate the shares that Romer has to issue.

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$65 / $150 x 2,000 shares = 867 shares that need to be issued

b) Calculate the combined UPA

($ 50,000 + $ 10,000) / (5,000 + 867) = 10.23

c) Calculate the P/U paid ratio

Offered price / UPA of target company = $65.00 / $5.00 = 13

d) Compare P/U paid with the current P/U

Given that 13 is less than the current ratio of 15, there should be no dilution of UPS for the company.
combined

e) Calculate the maximum price before the dilution of UPA

15 = price / $ 5.00. This implies that the price is $ 75.00. This is the maximum price that Romer
should pay before UPA are diluted.

Problem 6 (M&A)

Pizza Place is a pizza chain that is considering acquiring a smaller chain.

Western Mountain Pizza. Pizza Place analysts project that the merger will generate a flow
net incremental cash flow for the shareholder of $1.5 million in year 1, $2 million in year 2,
$3 million in year 3, and $5 million in year 4. Additionally, it is expected that the flows of
Western box of year 4 will grow at a constant rate of 5% after year 4. Assume that
All cash flows occur at the end of the year. The acquisition will be immediate. If it is
achieved, the post-merger beta of Western is estimated to be 1.5, and its tax rate will be the
40%. The risk-free rate is 6% and the market premium is 4%. What is the value of Western?
Mountain Pizza for Pizza Place?

Solution

0 12 1 2 3 4

1.5 2.0 3.0 5.0

VT = 75.0*
equals 80.0

= 6% + 6%
= 12%

$5 × 1.5
∗ = $75.00
0.12 − 0.05
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4× (1 + g) $5 × (1.05)
= = = $75
− 0.12 − 0.05

∧ 1 2 3 4
0 = + + +
(1 + r)1(1 + r)2(1 + r)3(1 + r)4

∧
1.5 2.0 3.0 80
0 = + + 3 +
(1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12)4
1 2

∧= 1.34 + 1.59 + 2.14 + 50.84

0

∧ $55.91 million
0

Problem 7 (M&A)

Harrison Coporation is interested in acquiring Van Buren Corporation. Assume that the rate
the risk-free rate is 5% and the market risk premium is 6%
Van Buren is currently expecting to pay a dividend of $2.00 per share at the end of the year.
(D1$2.00). Van Buren's dividends are expected to grow at a constant rate of 5% and
that has a beta of 0.9.
What is the price of Van Buren's stocks?

= 5% + 6% × 0.9

= 10.4%

∧ 0× (1 + g) 1 2 × (1 + 5%)
0 = = = = $37.04
− 0.104 − 0.05 0.104 − 0.05

Harrison estimates that if he acquires Van Buren, the year-end dividends will remain at
$2.00 per share, but the synergies will allow dividends to grow at a steady rate
of 7% per year (instead of 5%). Harrison also plans to increase the debt ratio of
what will be its subsidiary Van Buren. The effect will be to increase Van Buren's beta to 1.1.
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What is the stock price of Van Buren for Harrison Corporation?

= 5% + 6% × 1.1

= 11.6%

∧ 0× (1 + g) 1
0 = = = $43.48
− 0.116 − 0.07
The next dividend (the end of year one) does not change. What changes is the growth rate.
forward, what is recorded in the denominator.
Based on the information from the previous problems, if Harrison decided to acquire Van
Buren, what would be the price range you would offer for Van Buren's shares?
The offer should be between $37.04 and $43.48

Problem 8 (M&A)

Apilado Appliance Corporation is considering a merger with Vaccaro Vacuum Company,

Vaccaro is publicly traded, and its current beta is 1.30. Vaccaro has been scarcely profitable and
pays a tax rate of 20% in taxes for several years. Additionally, it uses little
debt, having a ratio of only 25%
If the acquisition were to take place, Apilado would operate Vaccaro as a separate subsidiary.
I would pay taxes on a consolidated basis, so my rate would increase to 35%. Stacked
it would also increase the debt of its subsidiary Vaccaro to 40% of the assets, which
it would increase the equity beta to 1.47. The M&A division of Apilado estimates that Vaccaro, if it is
acquired, it would produce the following net free cash flows for the shareholders of Apilado (in
millions of dollars

Year Net Free Cash Flow

1 $1.30
2 $1.50
3 $1.75
4 $2.00
5 and later Constant growth of 6%

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

a) What should be the discount rate to use to discount the flows?

projected cash box (note: use the market risk premium of Stacked)
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For Stacked
= + ×

14% = 8% + Market Price × 1

Primera Mercadop = 6%
For Vaccaro
= + ×

= 8% + 6% × 1.47

= 16.82%
The discount rate that should be used in this case is the discount rate of the
Vaccaro's assets with the new borrowing conditions, beta, others.

b) What is the dollar value of Vaccaro for Stacking?

∧ 0× (1 + g) $2 × 1.06
0 = = $19.59 (Value Terminal)
− 0.1682 − 0.06

∧ 1 2 3 4
0 = + + +
(1 + r)1(1 + r)2(1 + r)3(1 + r)4

∧
1.3 1.5 1.75 21.59
0 = + + +
(1 + 0.1682) (1 + 0.1682) (1 + 0.1682) (1 + 0.1682)4
1 2 3

∧ 1.11 + 1.10 + 1.10 + 11.60

0

∧ $14.91 million
0
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Problem 9 (M&A)

TansWorld Communication Inc, a large telecommunications company, is evaluating a

possible acquisition of Georgia Cable Company (GCC), a regional cable company. The
TransWorld's M&A division projects the following information for GCC post-merger.
thousands of dollars

2022 2023 2024 2025

Net Sales $450 $518 $555 $600
Administration and Sales Expenses $45 $53 $60 $68
Interest $18 $21 $24 $27

Tax rate after the merger: 35%

Cost of goods as % of sales: 65%
Beta after the merger: 1.50
Risk-free rate: 8%
Market risk premium: 4%
Long-term growth rate of free cash flows available for TransWorld: 7%

- If the acquisition takes place, it will occur on January 1, 2022. All cash flows in the
Financial statements are assumed to occur at the end of the year.
- GCC currently has a capital structure of 40% debt, but TransWorld
It will increase to 50% if the acquisition is made.
- GCC, independent will pay a tax of 20%, but its income would pay a tax of
35% if they consolidate.
- The current beta of GCC is 1.40 and its investment bankers believe that the beta
the debt ratio will increase to 1.50 as it rises to 50%.
- The cost of the goods is expected to be 65%, but it could vary to some extent.
- The cash flows generated by the depreciation will be used to replace old equipment.
so they will not be available to shareholders.
- The risk-free rate is 8% and the market risk premium is 4%.

a) What is the appropriate rate to value the acquisition?

b) What is the terminal value? What is the value of GCC for TransWorld?
c) Assume that the sales in each year were $100,000 greater than the amounts in the scenario.
base and that the ratio of (cost of goods / sales) was 60% instead of 65%. What would be the
value of GCC for TransWorld with these assumptions?
d) With sales and costs of goods at the levels established in part C, what would be the value of
GCC for TransWorld if its beta were 1.60, if the risk-free rate rose to 9% and the premium
would market risk rise to 5%?
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e) Keeping all values at their levels as in part d), what would be the value of GCC
for TransWorld if the terminal growth were to increase to 12% or decrease to 3%?

2022 2023 2024

Net Sales 450 518 555 600
Costs 65% -293 -337 -361 -390
Administration and Sales Expenses -45 -53 -60 -68
Interest -18 -21 -24 -27
Taxes -33 -38 -39 -40
Net Result 61 70 72 75
Terminal Value of Cash Flows 0 0 0 1143
Net Cash Flow for TransWorld 61 70 72 1217

Beta after fusion 1.5 Debt ratio after merger 50%

Risk-free rate 8% Tax rate after merger 35%
Market risk premium 4% Terminal Growth Rate 7%

Cost of Equity 14% Value of the Acquisition 877

Valor Terminal 1143

a) If we use the cash flow for shareholders considering that it has debt, the cost
it should be what the shareholders demand, that is 14%
b) El valor terminal es 1.143 y el valor de Georgia Cable para Transworld es 877
The value of GCC for TransWorld would be 1414
d) The value of GCC for TransWorld would be 993
e) If the growth rate were 12%, the value of GCC for TransWorld would be 1.743. If the rate
growth outside 3%, the value of GCC for TransWorld would be 778