Exercise Vision is seeking to acquire Scope. Vision expects that the merger will

Question

Exercise Vision is seeking to acquire Scope. Vision expects that the merger will yield an additional after-tax cash flow of $120,000, which is expected to grow at 3% per year. Vision is now earning $200,000 and has a current share price of $4 per share (with Im shares on issue), and Scope is earning $500,000 and has a current share price of $1 per share (with 5m shares on issue). The cost of capital of the merged firm is expected to be l 1%. Vision is offering a cash price of $1.2 per share to acquire Scope and the money for this cash offer be raised by selling new shares. 1. Calculate the Synergy and the NPV of the merger. 2. Calculate the share price and P/E ratio after the merger 3. If Vision buys Scope using its large cash reserves, what will be the market value of the merged firm?

Explanation / Answer

1) Additional after tax cashflow = 120000 Cost of capital of merged firm = 11% Growth in post tax earnings = 3% Premium = Cash payments - Value of scope No of shares x 1.2 - No. of shares x Share price (5000000 x 1.2 ) - (5000000 x 1) 1000000 NPV of merger = 120000/(0.11 - 0.03) = 1500000 Synergy = Premium + NPV 1000000 + 1500000 2500000 2) Value of Vision after merger = Value of Vision + value of Scope + Value of synergy                 = 4 x 1000000 + 5000000 x 1 + 2500000                 = 4000000 +5000000 + 2500000                 = 11500000 No. of shares = Existing shares + New issued shares 1000000 + (1.2 x 5000000/4) 2500000 Price per share = Value of merged firm/No. of shares 11500000/2500000 4.6 Earnings after merger = 200000 + 500000 + 120000 820000 Earnings per share after merger = Earnings / No. of shares 820000/2500000 0.328 P/E Ratio = Price / EPS 4.6/0.328 14.02439 times 3) If vision uses cash reserves then the no. of shares will remain the same as before. Value pf merged firm = Value of Vision + value of Scope + Value of synergy - cash payment 11500000 - 1.2 x 5000000 5500000

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