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25 August, 13:50

Fly-By-Night Couriers is analyzing the possible acquisition of Flash-in-the-Pan Restaurants. Neither firm has debt. The forecasts of Fly-By-Night show that the purchase would increase its annual aftertax cash flow by $370,000 indefinitely. The current market value of Flash-in-the-Pan is $9 million. The current market value of Fly-By-Night is $23 million. The appropriate discount rate for the incremental cash flows is 8 percent. Fly-By-Night is trying to decide whether it should offer 35 percent of its stock or $13 million in cash to Flash-in-the-Pan.

a. What is the synergy from the merger?

b. What is the value of Flash-in-the-Pan to Fly-By-Night?

c. What is the cost to Fly-By-Night of each alternative?

d. What is the NPV to Fly-By-Night of each alternative?

e. Which alternative should Fly-By-Night use?

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Answers (1)
  1. 25 August, 16:15
    0
    a. The synergy will be the present value of the incremental cash flows of the proposed purchase.

    Since the cash flows are perpetual, this amount is $370,000/.08

    =$370000/.08

    =$4,625,000

    b

    The value of Flash-in-the-Pan to Fly-by-Night is the synergy plus the current market value of Flash-in-the-Pan

    = $4625000+9000000

    =$13625000

    c

    stocked acquired = percentage age of ownership x value of merged firm

    0.35 (13625000 + 23000000)

    = $12818750

    d

    NPVs = Value of Flash-in-the-Pan to Fly-by-Night - (equivalent) cash offer = synergy - cost:

    NPV of cash alternative = 13625000 - 13000000 = $625,000

    NPV of stock alternative = 13625000 - 12818750 = $806,250

    e

    Use the Stock Alternative, Because NPV is better
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