Question

Velcro Saddles is contemplating the acquisition of Skiers' Airbags Inc. The values of the two companies as separate entities are $28 million and $14 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $540,000 per year in perpetuity. Velcro Saddles can either pay $18 million cash for Skiers' or offer Skiers' a 46% holding in Velcro Saddles. The opportunity cost of capital is 10%. Required: a. What is the gain from merger? (Enter your answer in millions rounded to 2 decimal places.) b. What is the cost of the cash offer? (Enter your answer in millions.) c. What is the cost of the stock alternative? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) d. What is the NPV of the acquisition under the cash offer? (Enter your answer in millions rounded to 2 decimal places.) e. 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.) Merger gain Cost of cash offer Cost of stock offer NPV of cash offer NPV of stock offer Answer is not complete. $ 5.40 million S 4 million S 6.44 million million million

Answer 1

Solution:
a.	Merger gain	5.40	million
b.	cost of the cash offer	4	million
c.	cost of the stock alternative	7.80	million
d.	NPV of cash offer	1.40	million
e.	NPV of stock offer	-2.40	million
Working Notes:
		$5.40 million
a.	Merger gain
Notes:	Merger gain = present value of gain per annum due to merger
	Merger gain = Marketing & admin cost reduction per annum/cost of capital
	Merger gain = $540,000/10%
	Merger gain = $5,400,000
	Merger gain = $5.40 million
Notes:	Since cost reduction benefit is perpetual hence it present value is computed by dividing perpetual cash flows by opportunity cost of capital
b.	cost of the cash offer	$4   million
Working Notes:
	cost of the cash offer
	= Cash paid - value of the company received
	=$18 million - $14 million
	=$4 million
c.	cost of the stock alternative	$7.80	million
Working Notes:
	cost of the stock alternative
	= (Combined value of the company after merger x % given) - value of the company received Skiers
Notes:	Combined value of the company after merger
	= Individual value of each company + gain of merger
	=$28 + $14 + $5.40
	=$47.4 million
	cost of the stock alternative
	= ($47.4 million x 46%) - $14 million
	=$21.804 - $14 million
	=$7.804 million
	=$7.80 million
d.	NPV of the acquisition under the cash offer	$1.40	million
Working Notes:
	NPV of cash offer
	= Merger gain -cost of the cash offer
	=$5.40 million - $4 million
	=$1.40 million
e.	NPV of stock offer	-$2.40 million
Working Notes:
	NPV of stock offer
	=Merger gain -cost of the stock alternative
	=$5.40 million -$7.804 million
	= -$2.404 million
	= -$2.40 million
Please feel free to ask if anything about above solution in comment section of the question.