Fantastic Three Ltd. has attracted a lot of attention in the market because of i
ID: 2761493 • Letter: F
Question
Fantastic Three Ltd. has attracted a lot of attention in the market because of its high potential. The company has 20,000 shares outstanding that are currently trading at $20. Both OU Inc and Texas Inc have shown interest in the acquisition of Fantastic Three. OU has a market value of $1 million and 100,000 shares outstanding, while Texas has 500,000 shares trading at $15. In order to acquire Fantastic Three, OU has offered to pay to Fantastic's shareholders $600,000 cash, while Texas has offered to issue 40,000 new shares as a payment.
a) What is the minimum yearly amount of synergies created by the merger, respectively for OU and Texas that would justify such offers? Assume synergies are perpetual and the correct discount rate is 10% for both companies.
b) Assume yearly synergies from the merger with Fantastic Three would be $25,000 in perpetuity for both OU and Texas. What offer should Fantastic's shareholders accept?
Explanation / Answer
Solution:
(a) NPV of the acquisition is difference between synergies and costs. Both OU and Texas should get synergies from the merger (Sy) are high enough to cover the costs. Therefore, the firm OU the minimum amount of synergies obtained from the equation:
NPV = Value + Sy/r – C
0 = 20,000 x $20 + Sy/0.1 - $600,000
0 = $400,000 + Sy/0.1 - $600,000
Sy/0.1 = $200,000
Sy = 0.1*$200,000
Sy = $20,000
Similarly for Texas, we have
NPV = Value + Sy/r – C
0 = 20,000 x $20 + Sy/0.1 – 40,000/540,000 ($7,500,000 + $400,000 + Sy/0.1)
0 = $400,000 + Sy/0.1 – ($555,555.6 + 29,629.63 + 7.407407Sy)
2.5925926Sy = $185,185.19
Sy = $20,000
(b) If they accept the offer of firm OU, they get $600,000 and if they accept the offer of firm Texas they get
40,000/540,000 ($7,500,000 + $400,000 + $200,000) = $600,000
Hence, they are indifferent.
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