Mergers

By
Carlos A. Coln De Armas
November 26, 2013

BMA, Chapter 31, Problem #12

(Same as BMA, 9th ed., Ch. 32, Practice Question #12 and BMA, 10th ed., Ch. 31, Problem #12)

First, calculate the required rate for Plastitoys

under current conditions:
$0.80 (1.06)
$0.848
=
= $20
r 0.06
r 0.06
$0.848
r 0.06 =
$20
r = 0.0424 + 0.06 = 10.24% 10%

BMA, Chapter 31, Problem #12 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #12 and BMA, 10th ed., Ch. 31, Problem #12)

Then, estimate the price per share of

Plastitoys under the assumption that new
management increases growth rate to 8%:
$0.80 (1.08)
$0.864
P =
=
= $43.20
0.10 0.08
0.02

BMA, Chapter 31, Problem #12 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #12 and BMA, 10th ed., Ch. 31, Problem #12)

a) What is the gain from the acquisition?

PVAB

=
=
=

($90 X 1,000,000) + ($43.20 X 600,000)

$90,000,000 + $25,920,000
$115,920,000

Gain

=
=
=
=

PVAB - (PVA + PVB)

$115,920,000 - ($90,000,000 + $12,000,000)
$115,920,000 - $102,000,000
$13,920,000
Alternative calculation:
Gain = ($43.20 - $20.00) X 600,000
= $23.20 X 600,000
= $13,920,000

BMA, Chapter 31, Problem #12 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #12 and BMA, 10th ed., Ch. 31, Problem #12)

b) What is the cost of the acquisition if Leisure

Products pays $25 in cash for each share of
Plastitoys?
Cost

=
=
=

($25 X 600,000) - $12,000,000

$15,000,000 - $12,000,000
$3,000,000

NPV

=
=

$13,920,000 - $3,000,000
$10,920,000

BMA, Chapter 31, Problem #12 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #12 and BMA, 10th ed., Ch. 31, Problem #12)

c) What is the cost of the acquisition if Leisure

Products offers one share of Leisure Products for
every three shares of Plastitoys?
Number of shares of LP outstanding after merger = 1,000,000 +
Estimated price per share of LP after merger =

600,000
= 1,200,000
3

$115,920,000
= $96.60
1,200,000

Cost

=
=
=

($96.60 X 200,000) - $12,000,000

$19,320,000 - $12,000,000
$7,320,000

NPV

=
=

$13,920,000 - $7,320,000
$6,620,000

BMA, Chapter 31, Problem #12 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #12 and BMA, 10th ed., Ch. 31, Problem #12)

d)

How would the cost of the cash offer and the share offer alter if
the expected growth rate of Plastitoys were not changed by the
merger?

Cash offer:
Cost

$3,000,000 (same as before)

NPV

$0 - $3,000,000 = -$3,000,000

$102,000,000

Share offer:
PVAB

Estimated price per share of LP after merger = $102,000,000 / 1,200,000 = $85

Cost

=
=
=

($85 X 200,000) - $12,000,000

$17,000,000 - $12,000,000
$5,000,000

NPV

$0 - $5,000,000 = -$5,000,000

BMA, Chapter 31, Problem #13

(Same as BMA, 9th ed., Ch. 32, Practice Question #13 and BMA, 10th ed., Ch. 31, Problem #13)

World Enterprises

Wheelrim and Axle

Merged Firm

$2.00

$2.50

$2.67

Price per share

$40

$25

Price-earnings ratio

20

10

Number of shares

100,000

200,000

Total earnings

$200,000

$500,000

$4,000,000

$5,000,000

Earnings per share

Total market value

BMA, Chapter 31, Problem #13 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #13 and BMA, 10th ed., Ch. 31, Problem #13)

Total market value = $4,000,000 + $5,000,000 = $9,000,000

Total earnings = $200,000 + $500,000 = $700,000
EPS = $2.67 implies that,
$700,000
= $2.67,
Number of shares

therefore,

Number of shares =

Price per share = $9,000,000 / 262,172 = $34.33

Price-earnings ratio = $34.33 / $2.67 = 12.9

$700,000
= 262,172
$2.67

BMA, Chapter 31, Problem #13 (cont.)

(Same as BMA, 9th ed., Ch. 32, Practice Question #13 and BMA, 10th ed., Ch. 31, Problem #13)

World enterprises issued (262,172 - 100,000) = 162,272 new shares

Thus, (162,172 / 200,000) = 0.81 shares of World Enterprises were
exchanged for each share of Wheelrim and Axle.
Therefore, World Enterprises paid a total of (162,172 X $34.33) =
$5,567,365 for a firm worth $5,000,000. Thus,
Cost = $5,567,365 - $5,000,000 = $567,365
As a result, one would expect that the market value of World Enterprises
will decrease by $567,365:
NPV = $0 - $567,365 = -$567,365

Sensible Motives for Mergers

(BMA, Chapter 31, Section 31.1)

Economies of scales
Economies of vertical integration
Complementary resources
Surplus funds? (Why not pay the money to the
stockholders?)
Eliminating inefficiencies (Mergers as part of the
labor market?)
Industry consolidation

Dubious Reasons for Mergers

(BMA, Chapter 31, Section 31.2)
Diversification (See illustration)
Increasing EPS (Chapter 31, Problem #13)
Lower financing costs

Diversification at the
Firm Level
Shareholders

Coats, Inc.

Umbrellas, Inc.

Bathing Suits, Inc.

Sun Block, Inc.

Diversification at the
Shareholder Level
Shareholders

Umbrellas, Inc.

Coats, Inc.

Bathing Suits,
Inc.

Sun Block, Inc.