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Autumn 2005- TBS 907- Tutorial 5 - Mergers and Acquisitions- Solutions

# Autumn 2005- TBS 907- Tutorial 5 - Mergers and Acquisitions- Solutions

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TBS 907- AUTUMN 2005 TUTORIAL 5- MERGER AND ACQUISTIONS SOLUTIONS Question 1 YAM Ltd (Y) has been evaluating the acquisition of Xavier Ltd (X). The annual expected cash flows of Y and X are respectively, \$1.16 million per annum in perpetuity and \$640,000 per annum in perpetuity. These cash flows are expected to be unaffected by the takeover. The systematic risk (beta) of Y is 0.75 and of X is 1.0. The risk free interest rate is 10 percent and the expected excess return on the market portfolio is 6 percent. Calculate the price at which X represents a zero NPV investment. Is it likely that Y’s shareholders will benefit from the takeover? Assume the information in the previous paragraph, except that the post takeover cash flow of the two companies is expected to be \$1.95 million per annum in perpetuity. Is the acquisition likely to e of benefit to Y’s shareholders? Answer: 1. Using the CAPM: k X = 0.10 + 1.0 (0.06) = 0.16 V X = m m 4 16 . 0 64 . 0 \$ = The value of X as an independent entity is \$4m and it is a zero NPV investment at that price. Since the takeover is not expected to change the company’s net cash flows, there is no gain from the takeover and no benefit to Y ’s shareholders. 2. k X = 0.16 k y = 0.10 + .75(.06)= .145 Using X’s cost of Capital, value of the combined company = 1.95m/.16=12.1275m Gain from the merger= 12.1875 – 12m = \$187,500 Based on this Y’ shareholders will benefit as long as the price paid for X is less than \$4.1875m.

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Autumn 2005- TBS 907- Tutorial 5 - Mergers and Acquisitions- Solutions

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