Chapter 29 Mergers and Acquisitions(2)

Example of merger valuation, continued

What will be the Weighted Average Cost of Capital or WACC of the combined Firm AB. Let’s assume that A and B contribute proportionally (here, weighted by existing intrinsic values VA and VB) to the new WACCAB.

WACCAB = [VA/(VA+VB)](WACCA) + [VB/(VA+VB)](WACCB) WACCAB = [25,000/(25,000+1250)](0.10) + [1250/(25,000+1250)](0.12) = 0.100952 or 10.0952%WSU EMBA Corporate Finance 29-17

Chapter 29 Mergers and Acquisitions

Example of merger valuation, continued

What is the proposed Firm AB worth? What price should Firm A pay? First, estimate the value of the combined Firm AB. Assume the FCF growth rate remains at g=6% per year.

VAB=FCFAB/(waccAB – g) = 1130M/(0.10092 – 0.06) = $27,593.28M Vsynergy = VAB – (VA + VB) = 27593.28M – (25,000M + 1250M) = $1343.04M

The merged Firm AB is worth $27,593.28M, which is $1343.04M more than the firms are worth as stand-alone firms. Also the synergy or NPV of this merger is $1343.04M. This merger makes economic sense. However, at what price will Firm A be able to acquire Firm B?WSU EMBA Corporate Finance 29-18

Chapter 29 Mergers and Acquisitions

Example of merger valuation, continued

Scenario 1: What if Firm A pays a price that allocates all of the Vsynergy or merger NPV to the existing Firm A shareholders? The entire merger synergy or NPV will become impounded into the Firm A shares.

This involves paying $1250M or $12.50 per share for all the existing Firm B shares. Basically, Firm B shareholders are selling at the existing Firm B stock price of $12.50 per share! New Firm A value = (VA + Vsynergy)/500M shares or (25,000M + 1342.04M)/500M = $52.69 per share Firm B shareholders are unlikely to approve such an offer.WSU EMBA Corporate Finance 29-19