ABC Corp. is considering purchasing XYZ Corp. Both firms are all equity firms. T
ID: 2613041 • Letter: A
Question
ABC Corp. is considering purchasing XYZ Corp. Both firms are all equity firms. The current market value of ABC Corp. is $100 million and the current market value of XYZ Corp. is $30 million. If the firms merge, the entire synergy gain from the deal will arise from layoffs and cost cutting. ABC Corp. estimates that these layoffs and cost cutting efforts will save the merged entity $1 million annually in perpetuity. The appropriate discount rate for any cost savings is 10%. Firm ABC currently has 7 million shares outstanding and Firm XYZ currently has 2 million shares outstanding. (a) What is the total synergy gain from this merger? (b) What is the most that ABC Corp. would be willing to pay for XYZ Corp. in a cash acquisition? (c) ABC Corp. is trying to decide whether it should offer 25 percent of its stock or $38 million in cash for XYZ Corp. Which of these choices is more attractive to ABC Corp.? Which of these choices is more attractive to XYZ Corp.? (d) Suppose ABC Corp. announces that it is acquiring XYZ Corp. in a stock swap in which XYZ Corp. shareholders will receive 3 newly issued shares of ABC stock for each 2 shares of XYZ Corp. that they currently hold. Assuming the share prices before the merger do not reflect any merger anticipation, what will be the percentage change in the share price of (i) ABC Corp. and (ii) XYZ Corp. when the deal is announced? (assume the market believes after the announcement that the deal will surely be completed) (e) Calculate the percentage change in the share prices when a deal is announced for both the bidder and the target if a cash acquisition is announced and the price of the acquisition is (i) $25 million, (ii) $35 million, and (iii) $45 million.
Explanation / Answer
(a) What is the total synergy gain from this merger? Cash flows are perpetual, the synergy value is: Synergy Gain $1,000,000 Rate 10% Total Synergy Gain from this Merger = $1,000,000/10% $10,000,000 (b) What is the most that ABC Corp. would be willing to pay for XYZ Corp. in a cash acquisition? Total cash Acquisition = Current Market Value of XYZ co. + Total Synergy Total cash Acquisition = $30,000,000+$10,000,000 $40,000,000 (c) ABC Corp. is trying to decide whether it should offer 25 percent of its stock or $38 million in cash for XYZ Corp. Which of these choices is more attractive to ABC Corp.? Which of these choices is more attractive to XYZ Corp.? a. 25% of stock ABC corp outstanding Shares 7,000,000 shares Offer 1 = 25% x 7,000,000 1750000 shares Current market price = $100million/ 7 million shares $14.29 per share Total offer value $25,000,000.00 b. Cash $38,000,000 25% of stock offer is more attractive to ABC corp.because they don't need to pay cash Cash option is more attractive to XYZ corp.because the amount of cash paid is more than percentage of ownership in the merged company.