Question

Velcro Saddles is contemplating the acquisition of Skiers’ Airbags Inc. The values of the two companies as separate entities are $38 million and $19 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $590,000 per year in perpetuity. Velcro Saddles can either pay $23 million cash for Skiers’ or offer Skiers’ a 44% holding in Velcro Saddles. The opportunity cost of capital is 10%.

Required:

1. What is the gain from merger? (Enter your answer in millions rounded to 2 decimal places.)
2. What is the cost of the cash offer? (Enter your answer in millions.)
3. What is the cost of the stock alternative? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
4. What is the NPV of the acquisition under the cash offer? (Enter your answer in millions rounded to 2 decimal places.)
5. What is its NPV under the stock offer? (Do not round intermediate calculations. A negative answer should be indicated by a minus sign. Enter your answer in millions rounded to 2 decimal places.)

Answer 1

1) Gain From Merger = $590,000 / 0.10 =	$                 5.90	Millions
2) Cost of the Cash Offered = $23 Million - $19 Million	$                 4.00	Millions
3)
Total Value of Merged co.= $38 million + $19 million + $5.9 million (from cost savings) =	$               62.90	millions
Since the Skiers shareholders own half of the firm, their stock is now worth $62.90 x 1/2	$               31.45	millions
Cost of Stock alternativ3 = $31.45 millions - $19 millions	$               12.45	millions
4) NPV of Acquisition =  = $5.90 million -$4 million	$                 1.90	Millions
5) NPV under Stock offer = $5.90 Millions  - $12.45 millions	$               (6.55)	Millions