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Unformatted text preview: Chapter 30: Mergers and Acquisitions 30.1 The new corporation issues $300,000 in new debt. The merger creates $100,000 of goodwill because the merger is a purchase. Balance Sheet Lager Brewing (in $ thousands) Current assets $480 Current liabilities Other assets 140 Long-term debt Net fixed assets 580 Equity Goodwill 100 Total assets $1,300 Total liabilities 30.2 If the balance sheet for Philadelphia Pretzel shows assets at book value instead of market value, the goodwill will be only $60,000 (=$300,000 - $240,000). Thus, the net fixed assets are $620,000 (=$1,300,000 - $480,000 - $140,000 - $60,000). Balance Sheet Lager Brewing (in $ thousands) $480 140 620 60 $1,300 Balance Sheet Lager Brewing (in $ thousands) Current assets Other assets Net fixed assets Total assets 30.4 a. b. c. d. e. $480 140 580 $1,200 Current liabilities Long-term debt Equity Total liabilities $280 100 820 $1,200 $200 400 700 $1,300 Current assets Other assets Net fixed assets Goodwill Total assets 30.3 Current liabilities Long-term debt Equity Total liabilities $200 400 700 $1,300 False. Although the reasoning seems correct, the Stillman-Eckbo data do not support the monopoly power theory. True. When managers act in their own interest, acquisitions are an important control device for shareholders. It appears that some acquisitions and takeovers are the consequence of underlying conflicts between managers and shareholders. False. Even if markets are efficient, the presence of synergy will make the value of the combined firm different from the sum of the values of the separate firms. Incremental cash flows provide the positive NPV of the transaction. False. In an efficient market, traders will value takeovers based on "Fundamental factors" regardless of the time horizon. Recall that the evidence as a whole suggests efficiency in the markets. Mergers should be no different. False. The tax effect of an acquisition depends on whether the merger is taxable or non-taxable. In a taxable merger, there are two opposing factors to consider, the capital gains effect and the write-up effect. The net effect is the sum of these two effects. Answers to End-of-Chapter Problems B-233 f. True. Because of the coinsurance effect, wealth might be transferred from the stockholders to the bondholders. Acquisition analysis usually disregards this effect and considers only the total value. (in $ millions) Net Cash Flow Per Year (Perpetual) 8 20 5 2.5 2 0.5 $33 Discount Rate (%) 16% 10% 11.76% 20% 10% 5% 11.28% Value 50 200 42.5 12.5 20 10 $292.5 30.5 Small Fry Whale Benefits from Acquisition: Revenue Enhancement Cost Reduction Tax Shelters Whale-Fry Per share price = ($292.5-100)/5 = $38.5 30.6 a. The weather conditions are independent. Thus, the joint probabilities are the products of the individual probabilities. Possible states Rain Rain Rain Warm Rain Hot Warm Rain Warm Warm Warm Hot Hot Rain Hot Warm Hot Hot Joint probability 0.1 x 0.1=0.01 0.1 x 0.4=0.04 0.1 x 0.5=0.05 0.4 x 0.1=0.04 0.4 x 0.4=0.16 0.4 x 0.5=0.20 0.5 x 0.1=0.05 0.5 x 0.4=0.20 0.5 x 0.5=0.25 Since the state Rain Warm has the same outcome (revenue) as Warm Rain, their probabilities can be added. The same is true of Rain Hot, Hot Rain and Warm Hot, Hot Warm. Thus the joint probabilities are Possible states Rain Rain Rain Warm Rain Hot Warm Warm Warm Hot Hot Hot Joint probability 0.01 0.08 0.10 0.16 0.40 0.25 The joint values are the sums of the values of the two companies for the particular state. Possible states Rain Rain Rain Warm Warm Warm Joint value $200,000 300,000 400,000 B-234 Answers to End-of-Chapter Problems Rain Hot Warm Hot Hot Hot 500,000 600,000 800,000 b. Recall, if a firm cannot service its debt, the bondholders receive the value of the assets. Thus, the value of the debt is the value of the company if the face value of the debt is greater than the value of the company. If the value of the company is greater than the value of the debt, the value of the debt is its face value. Here the value of the common stock is always the residual value of the firm over the value of the debt. Joint Prob. 0.01 0.08 0.16 0.10 0.40 0.25 Joint Value $200,000 300,000 400,000 500,000 600,000 800,000 Debt Value $200,000 300,000 400,000 400,000 400,000 400,000 Stock Value $0 0 0 100,000 200,000 400,000 c. To show that the value of the combined firm is the sum of the individual values, you must show that the expected joint value is equal to the sum of the separate expected values. Expected joint value = 0.01($200,000) + 0.08($300,000) + 0.16($400,000) + 0.10($500,000) + 0.40($600,000) + 0.25($800,000) = $580,000 Since the firms are identical, the sum of the expected values is twice the expected value of either. Expected individual value = 0.1($100,000) + 0.4($200,000) + 0.5($400,000) = $290,000 Expected combined value = 2($290,000) = $580,000 d. The bondholders are better off if the value of the debt after the merger is greater than the value of the debt before the merger. Value of the debt before the merger: The value of debt for either company = 0.1($100,000) + 0.4($200,000) + 0.5($200,000) = $190,000 Total value of debt before the merger = 2($190,000) = $380,000 Answers to End-of-Chapter Problems B-235 Value of debt after the merger = 0.01($200,000) + 0.08($300,000) + 0.16($400,000) + 0.10($400,000) + 0.40($400,000) +0.25($400,000) = $390,000 The bondholders are $10,000 better off after the merger. 30.7 The decision hinges upon the risk of surviving. The final decision should hinge on the wealth transfer from bondholders to stockholders when risky projects are undertaken. High-risk projects will reduce the expected value of the bondholders' claims on the firm. The telecommunications business is riskier than the utilities business. If the total value of the firm does not change, the increase in risk should favor the stockholder. Hence, management should approve this transaction. Note, if the total value of the firm drops because of the transaction and the wealth effect is lower than the reduction in total value, management should reject the project. 30.8 If the market is "smart," the P/E ratio will not be constant. a. Value = $2,500 + $1,000 = $3,500 b. EPS = Post-merger earnings / Total number of shares =($100 + $100)/200 =$1 c. Price per share = Value/Total number of shares =$3,500/200 =$17.50 d. If the market is "fooled," the P/E ratio will be constant at $25. Value = P/E * Total number of shares = 25 * 200 = $5,000 EPS = Post-merger earnings / Total number of shares =$5,000/200 = $25.00 30.9 a. After the merger, Arcadia Financial will have 130,000 [=10,000 + (50,000)(6/10)] shares outstanding. The earnings of the combined firm will be $325,000. The earnings per share of the combined firm will be $2.50 (=$325,000/130,000). The acquisition will increase the EPS for the stockholders from $2.25 to $2.50. b. There will be no effect on the original Arcadia stockholders. No synergies exist in this merger since Arcadia is buying Coldran at its market price. Examining the relative values of the two firms sees the latter point. Share price of Arcadia = (16 * $225,000) / 100,000=$36 Share price of Coldran = (10.8 * $100,000) / 50,000=$21.60 The relative value of these prices is $21.6/$36 = 0.6. Since Coldran's shareholders receive 0.6 shares of Arcadia for every share of Coldran, no synergies exist. 30.10 a. The synergy will be the discounted incremental cash flows. Since the cash flows are perpetual, this amount is $600,000 = $7,500,000 0.08 B-236 Answers to End-of-Chapter Problems b.The value of Flash-in-the-Pan to Fly-by-Night is the synergy plus the current market value of Flash-in-the-Pan. V = $7,500,000 + $20,000,000 = $27,500,000 c. Cash alternative = $15,000,000 Stock alternative = 0.25($27,500,000 + $35,000,000) = $15,625,000 d. NPV of cash alternative = V - Cost =$27,500,000 - $15,000,000 =$12,500,000 NPV of stock alternative = V - Cost =$27,500,000 - $15,625,000 =$11,875,000 e. Use the cash alternative, its NPV is greater. 30.11 a. The value of Portland Industries before the merger is $9,000,000 (=750,000x12). This value is also the discounted value of the expected future dividends. $9,000,000 = $1.80 250,000)1.05 (r - 0.05) r = 0.1025 = 10.25% r is the risk-adjusted discount rate for Portland's expected future dividends. the value of Portland Industries after the merger is V= ($1.80 250,000)1.07 (0.1025 - 0.07) = $14,815,385
This is the value of Portland Industries to Freeport. b. NPV = Gain - Cost = $14,815,385 - ($40x250, 000) = $4,815,385 c. If Freeport offers stock, the value of Portland Industries to Freeport is the same, but the cost differs. Cost = (Fraction of combined firm owned by Portland's stockholders) x(Value of the combined firm) Value of the combined firm = (Value of Freeport before merger) + (Value of Portland to Freeport) = $15x1,000,000 + $14,815,385 = $29,815,385 Fraction of ownership = 600,000 = 0.375 1,000,000 + 600,000 Cost = 0.375x$29,815,385 = $11,180,769 NPV= $14,815,385 - $11,180,769 =$3,634,616 d. The acquisition should be attempted with a cash offer since it provides a higher NPV. e. The value of Portland Industries after the merger is V= ($1.80 250,000)1.06 = $11,223,529 (0.1025 - 0.06) Answers to End-of-Chapter Problems B-237 This is the value of Portland Industries to Freeport. NPV = Gain-Cost =$11,223,529 - ($40x250,000) =$1,223,529 If Freeport offers stock, the value of Portland Industries to Freeport is the same, but the cost differs. Cost = (Fraction of combined firm owned by Portland's stockholders) x(Value of the combined firm) Value of the combined firm = (Value of Freeport before merger) + (Value of Portland to Freeport) = $15x1,000,000 + $11,223,529 = $26,223,529 Fraction of ownership = 600,000 = 0.375 1,000,000 + 600,000 Cost = 0.375 * $26,223,529=$9,833,823 NPV = $11,223,529 - $9,833,823=$1,389,706 The acquisition should be attempted with a stock offer since it provides a higher NPV. 30.12 a. Number of shares after acquisition =30 + 15 = 45 mil Stock price of Harrods after acquisition = 1,000/45=22.22 pounds b. Value of Selfridge stockholders after merger: * 1,000 = 300 = 30% 30% = New shares issued = 12.86 mil 12.86:20 = 0.643:1 The proper exchange ratio should be 0.643 to make the stock offer's value to Selfridge equivalent to the cash offer. New Shares Issued New Shares Issued + Old Shares New Shares Issued = New Shares Issued + 30 30.13 To evaluate this proposal, look at the present value of the incremental cash flows. Cash Flows to Company A (in $ million) Year Acquisition of B 0 -550 1 2 3 4 5 B-238 Answers to End-of-Chapter Problems Dividends from B Tax-loss carryforwards Terminal value Total 150 -400 32 32 5 25 30 20 25 45 30 30 45 600 645 The additional cash flows from the tax-loss carry forwards and the proposed level of debt should be discounted at the cost of debt because they are determined with very little uncertainty. The after-tax cash flows are subject to normal business risk and must be discounted at a normal rate. Beta coefficient for the bond = 0.25 = [(8%-6%)/8%]. Beta coefficient for the company = 1 = [(0.25)2 + (1.25)(0.75)] Discount rate for normal operations: r = 6% + 8% (1) = 14% Discount rate for dividends: The new beta coefficient for the company, 1, must be the weighted average of the debt beta and the stock beta. 1 = 0.5(0.25) + 0.5(s) s = 1.75 r = 6% + 8%(1.75) = 20% $32 $5 $20 $30 $45 $25 $25 $900 $300 NPV = -$400 + + + + + + + + - 2 3 4 5 2 3 5 1.2 (1.2) (1.2) (1.2) (1.2) (1.08) (1.08) (1.14) (1.08) 5 = -$400 + $26.67 + $3.47 + $11.57 + $14.47 + $18.08 + $21.43 + $19.85 + $467.43 - $204.17 = -$21.2 Because the NPV of the acquisition is negative, Company A should not acquire Company B. 30.14 The commonly used defensive tactics by target-firm managers include: i. corporate charter amendments like super-majority amendment or staggering the election of board members. ii. repurchase standstill agreements. iii. exclusionary self-tenders. iv. going private and leveraged buyouts. v. other devices like golden parachutes, scorched earth strategy, poison pill, ..., etc. Answers to End-of-Chapter Problems B-239 Mini Case: U.S.Steel's case. You have 3 choices: tender, or do not tender or sell in the market. If you do sell your shares in the market, at some point, somebody else would need to make a decision in "tender" or "not tender" as well. It is important to recognize that the firm has about 60 million shares outstanding (since 30 million shares will give US Steel 50.1% of Marathon shares). Let's consider the possible selling prices, which you will receive for each of the following scenarios: US Steel Tender offer Tender Do not Tender Succeeds A pro-rated Price between $125 and $85 $85 Fails Market price Market price If US Steel's tender offer fails, you are equally well off since your share value is determined by the market price. If you choose not to tender, and 30 million shares were tendered US Steel succeeds to gain 50.1% control, you will only receive $85 a share. If you do tender, the price you will receive will be no worse than $85 a share and can be as high as $125 a share. Depending on the number of shares tendered, you will receive one of the following prices. 1. If only 50.1% tendered, you will get $125 per share. 2. If the shares tendered exceed 50.1% but less than 100%, you will get more than $105 a share. 3. If all 60 million shares were tendered, you will get $105 per share. (which is 30 ( $125) + 30 ( $85) ) 60 60 It is clear that, in the above 3 cases, when you are not sure about whether US Steel will succeed or not, you will be better off to tender your shares than not tender. This is because at best, you will only receive $85 per share if you choose not to tender. B-240 Answers to End-of-Chapter Problems ...
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