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Net Present Value and Exchange Ratio

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As with any other merger analysis, we need to examine the present value of the incremental cashflows. The cash flow today from the acquisition is the acquisition costs plus the dividends paidtoday, or:Acquisition of Hybrid–$550,000,000Dividends from Hybrid$150,000,000Total–$400,000,000Using the information provided, we can determine the cash flows to Birdie Golf from acquiringHybrid Golf. All earnings not retained are paid as dividends, so the cash flows for the next five yearswill be: Year 1Year 2Year 3Year 4Year 5

Dividends from Hybrid
$38,400,000$12,800,000$29,400,000$41,400,000$59,000,000

Terminal value of equity
600,000,000Total$38,400,000$12,800,000$29,400,000 $41,400,000$659,000,000

To discount the cash flows from the merger, we must discount each cash flow at the appropriatediscount rate. The terminal value of the company is subject to normal business risk and should bediscounted at the cost of capital, while the dividends are equity cash flows, and as such, should bediscounted at the cost of equity. The present value of each year’s cash flows, along with theappropriate discount rate for each cash flow is: Discount rateYear 1Year 2Year 3Year 4Year 5

Dividends 16.9%$32,848,589$9,366,578$18,403,643$22,168,806$27,025,856 PV of value
12.4%334,441,139Total$32,848,589$9,366,578$18,403,643$22,168,806$361,466,995

And the NPV of the acquisition is: NPV = –$400,000,000 + 32,848,589 + 9,366,578 + 18,403,643 + 22,168,806 + 361,466,995

NPV = $44,254,610.07

CHAPTER 25 C-83

C-84 CASE SOLUTIONS
2. Since the acquisition is a positive NPV project, the most Birdie would offer is to increase the currentcash offer by the current NPV, or:Highest offer = $550,000,000 + 44,254,610.07Highest offer = $594,254,610.07The highest share price is the total high offer price, divided by the shares outstanding, or:Highest share price = $594,254,610.07 / 8,000,000 sharesHighest share
price = $74.28 3.

To determine the current exchange ratio which would make a cash offer and a share offer equivalent,we need to determine the new share price under the original cash offer. The new share price of Birdie after the merger will be:P New

= ($94 × 18,000,000 + $44,254,610.07) / 18,000,000P
New
= $96.46So, the exchange ratio which would make the cash offer and share offer equivalent is:Exchange ratio = $68.75 / $96.46Exchange ratio = .7127 4.
The highest exchange ratio Birdie would accept is an exchange ratio that results in a zero NPVacquisition. This implies the share price of Birdie remains unchanged after the merger, so theexchange ratio is:Exchange ratio = $68.75 / $94Exchange ratio = .7314

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