Chapter 29
Ross, Westerfield and Jaffe
Evan, Inc., has offered $340 million cash
for all of the common stock in Tanner
Corporation. Based on recent market
information, Tanner is worth $317 million
as an independent operation. If the
merger makes economic sense for Evan,
what is the minimum estimated value of
the synergistic benefits from the merger?
Minimum economic value = $340,000,000 – 317,000,000 = $23,000,000
For the merger to make economic sense, the acquirer
must feel the acquisition will increase value by at
least the amount of the premium over the market
value
Consider the following premerger
information about firm X and firm Y:
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 post-merger balance sheet for Firm X assuming the
use of the purchase accounting method.
With the purchase method, the assets of the combined firm will be the book value of Firm X, the
acquiring company, plus the market value of Firm Y, the target company, so:
Assets from X = 46,800($21) = $982,800 (book value)
Assets from Y = 36,000($19) = $684,000 (market value)
The purchase price of Firm Y is the number of shares outstanding times the sum of the current stock
price per share plus the premium per share, so:
Purchase price of Y = 36,000($19 + 5) = $864,000
The goodwill created will be:
Goodwill = $864,000 – 684,000 = $180,000
And the total assets of the combined company will be:
Total assets XY = Total equity XY = $982,800 + 684,000 + 180,000 = $1,846,800
Assume that the following balance
sheets are stated at book value.
The fair market value of James’
fixed assets is equal to the book
value. Jurion pays $15,000 for
James and raises the needed funds
through an issue of long-term
debt. Construct a post-merger
balance sheet assuming that
Jurion Co. purchases James, Inc.,
and the purchase method of
accounting is used.
Post-merger long-term debt
Goodwill created
= $9,300 + 15,000
= $15,000 – $12400
= $24,300
= $2600
In the previous problem, suppose the fair market
value of James’s fixed assets is $15,000 versus the
$8,900 book value shown. Jurion pays $23,000 for
James and raises the needed funds through an issue
of long-term debt.
Construct the postmerger balance sheet now,
assuming that the purchase method of accounting is
used.
Post-merger long-term debt
Goodwill created
= $9,300 + 23,000
= $23,000 – $18500
= $32300
= $4500
Silver Enterprises has acquired All Gold
Mining in a merger transaction.
Construct the balance sheet for the
new corporation if the merger is
treated as a purchase for accounting
purposes. The market value of All Gold
Mining’s fixed assets is $5,800; the
market values for current and other
assets are the same as the book values.
Assume that Silver Enterprises issues
$13,800 in new long-term debt to
finance the acquisition. The following
balance
sheets
represent
the
premerger book values for both firms:
Post-merger long-term debt
Goodwill created
= $3,700 + 13,800
= $13,800 – $9,150
= $17,500
= $4,650
In the previous problem, construct the balance sheet
for the new corporation assuming that the
transaction is treated as a purchase for accounting
purposes. The market value of All Gold Mining’s fixed
assets is $5,800; the market values for current and
other assets are the same as the book values.
Assume that Silver Enterprises issues $10,500 in new
long-term debt to finance the acquisition.
Post-merger long-term debt
Goodwill created
= $3,700 + 10,500
= $10,500 – $9,150
= $14,200
= $1350
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 $1.1 million indefinitely. The current
market value of Teller is $45 million, and that of Penn is $62 million.
The appropriate discount rate for the incremental cash flows is 12
percent. Penn is trying to decide whether it should offer 40 percent of
its stock or $48 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?
Cash cost = $48 million
Stock cost:
Value of target to the acquirer = Value of the target firm + PV of the incremental CF
V
= $45,000,000 + $1,100,000/.12 = $54,166,667
Equity cost
= .40($62,000,000 + 54,166,667) = $46,466,667
NPV = Market value of Target + Synergistic Benefits – Acquisition cost
Synergy = 1,100,000/.12 = 9166666.7
NPV cash = 45,000,000 + $9166666.7 – 48,000,000 = $6,166,667
NPV stock = 45,000,000 + $9166666.7 – 46,466,667 = $7,700,000
The shareholders of Flannery Company have voted in favor of a buyout offer from
Stultz Corporation. Information about each firm is given here:
Price–earnings ratio
Shares outstanding
Earnings
Flannery
6.35
73,000
$230,000
Stultz
12.70
146,000
$690,000
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.
EPS of Stultz be after the merger?
EPS = Earnings / Number of shares outstanding
Earnings
= 230,000 + 690,000= 920000
Number of shares
= 146,000 + (1/3)(73,000) = 170333.33
EPS
= 920000/170333.33 = $5.401
What will the PE ratio be if the NPV of the acquisition is zero?
The market price of Stultz will remain unchanged if it is a zero NPV acquisition. Using
the PE ratio, we find the current market price of Stultz stock, which is:
P = 12.7($690,000)/146,000 = $60.02
If the acquisition has a zero NPV, the stock price should remain unchanged.
Therefore, the new PE will be:
P/E = $60.02/$5.401 = 11.11
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.
The value of Flannery to Stultz must be the market value of the company since the NPV of
the acquisition is zero. Therefore, the value is:
Value
= Earnings * PE ratio
V
= $230,000(6.35)
= $1,460,500
The cost of the acquisition is the number of shares offered times the share price, so the
cost is:
Cost
NPV
= (1/3)(73,000)($60.02) = $1,460,500
= Market value of Target + Synergistic Benefits – Acquisition cost
= 1,460,500
+ Synergistic Benefits - 1,460,500
0= Synergistic Benefits
Although there is no economic value to the takeover, it is possible that Stultz is motivated
to purchase Flannery for other than financial reasons
Consider the following premerger information about a bidding firm (Firm B) and a
target firm (Firm T). Assume that both firms have no debt outstanding.
Firm B
Firm T
Shares outstanding
4,800
1,200
Price per share
$36
$24
Firm B has estimated that the value of the synergistic benefits from acquiring Firm T
is $9,500.
a. If Firm T is willing to be acquired for $30 per share in cash, what is NPV of merger?
b. What will the price per share of the merged firm be assuming the conditions in (a)?
c. In part (a), what is the merger premium?
d. Suppose Firm T is agreeable to a merger by an exchange of stock. If B offers four of
its shares for every five of T’s shares, what will the price per share of the merged
firm be?
e. What is the NPV of the merger assuming the conditions in (d)?
a. If Firm T is willing to be acquired for $30 per share in cash, what is NPV of merger?
NPV
= Market value of Target + Synergistic Benefits – Acquisition cost
NPV
= 1,200($24) + $9,500 – 1,200($30) = $2,300
b. What will the price per share of the merged firm be assuming the conditions in (a)?
Since the NPV goes directly to stockholders, the share price of the merged firm will be
the market value of the acquiring firm plus the NPV of the acquisition, divided by the
number of shares outstanding, so:
Share price = [4,800($36) + $2,300]/4,800 = $36.48
c. In part (a), what is the merger premium?
Merger premium = 1,200($30 – 24) = $7,200
d. Suppose Firm T is agreeable to a merger by an
exchange of stock. If B offers four of its shares for
every five of T’s shares, what will the price per share
of the merged firm be?
The number of new shares will be the number of shares of the target times the
exchange ratio, so:
New shares created = 1,200(4/5) = 960 new shares
The value of the merged firm will be the market value of the acquirer plus the market
value of the target plus the synergy benefits, so:
VBT = 4,800($36) + 1,200($24) + $9,500 = $211,100
The price per share of the merged firm will be the value of the merged firm divided
by the total shares of the new firm, which is:
P = $211,100/(4,800 + 960) = $36.65
e. What is the NPV of the merger
assuming the conditions in (d)?
NPV
= Market value of Target + Synergistic Benefits – Acquisition cost
NPV
= 1,200($24) + $9,500 – 960($36.65)
= $3,116.67