Question

Hill, Inc.. plans to merge with Ravine Corp. Currently, the market value of Hill is 8 million euro and the market value of Ravine is I million euro if the companies are valued separately. After t merger, the company will enjoy economies of scale of 50 000 euro per year. which will last for 10 years, and then 20'000 euro per year forever. Hill will buy Ravine at a 20% premium in cash The cost of capital for both companies is 10% (a) What are the cost, gain and NPV of the merger? (b) Ravine Corp. has 250'000 shares outstanding. What will be the price per share of Ravine Corp. right after the merger is announcddiht: the cost of a merger is the gain realized by the shareholders of the acquired company (c) Hill, Inc. has 1 million shares outstanding. Instead of paying cash, it makes a stock offer. What share of the joint company should Hill propose to Ravine to pay the same premium on Ravine as in (a)? How many new shares should be issued? Compute the share price of the joint company.

Answer 1

a. Amount of consideration = Market Value of Ravine * (1 + Premium Rate)

= 1 million * (1 + 0.20)

= 1.2 million

Cost of merger = Amount of consideration - Market Value of Ravine

= 1.2 million - 1 million = 0.20 million = 200000

PV of economies of scale for first 10 years = 50000 * PVIFA (10%, 10 years)

= 50000 * 6.145 = 307250

Terminal economies of scale = 20000 / Cost of capital

= 20000 / 0.1 = 200000

PV of Terminal economies of scale = 200000 * PVIF (10%, 10 year)

= 200000 * 0.386 = 77200

Total PV of economies of scale = 307250 + 77200 = 384450

Thus Gain of merger = Total PV of economies of scale = 384450

NPV = Gain of merger - Cost of merger

= 384450 - 200000 = 184450

b. Existing share price of Ravine = Market value / no of shares outstanding

= 1 million / 250000 = 4

Gain from merger for Ravine = Amount of consideration - Market Value of Ravine

= 1.2 million - 1 million = 0.20 million = 200000

Gain per share = Gain from merger for Ravine / no of shares outstanding

= 200000 / 250000 = 0.80

Share price after merger = Existing share price + Gain per share

= 4 + 0.80 = 4.80

c. Value of merged company = Value of Hill + Value of Ravine + PV of economies of scale

= 8000000 + 1000000 + 384450 = 9384450

Share price of Hill = Market Value of Hill / No of shares outstanding

= 8 million / 1 million = 8

No of shares to be issued to Ravine = Amount of consideration / Share price of Hill

= 1200000 / 8 = 150000

Total no of shares issued by Hill = Existing outstanding shares + No of shares to be issued to Ravine

= 1000000 + 150000 = 1150000

Share price of merged company = Value of merged company / Total no of shares issued by Hill

= 9384450 / 150000 = 62.56