Group F Module 8 Mini Case

docx

School

St. Clair College *

*We aren’t endorsed by this school

Course

OAGN118

Subject

Finance

Date

Jan 9, 2024

Type

docx

Pages

Uploaded by DeanFerret3884

11/6/2023 Module 7 Mini Case Group F Sarah Deif Abdelshaheed Theodore Ibrahim Kassem Bazzi Huilin Shen Ke Yang

I NTRODUCTION A merger is being assessed for profitability between Dutton Golf Company and Elgin Gold Inc. Currently there is a cash offer of $250 million for Dutton Golf, and the impression is that a merger will capitalize on economies of scale in manufacturing and marketing which will result in synergies. There may also be an advantage in general and administrative expenses. Of note to consider is that following a merger, a dividend of $67.5 million would be paid from Dutton Gold to Elgin. Currently, Elgin Golf has 18 million shares outstanding at $87 per share and Dutton Golf has 8 million shares outstanding. The borrowing interest rate for both companies is 8%. The current cost of capital for Elgin Golf is 11% and 12.4% for Dutton Golf. The cost of equity for Dutton Golf is 16.9% and will be valued at $270 million in five years. This report will analyze the financial aspects of the potential merger to determine if $31.25 per share is reasonable enough to proceed with the merger, and what the highest price per share should be for Elgin to proceed. This report will also consider a stock exchange rather than a cash exchange and what exchange rate would make the merger terms equivalent to $31.25 per share. Finally this report will assess the highest exchange ration Elgin should be willing to pay to undertake the merger.

D ISCUSSION P ART I: S HOULD E LGIN P ROCEED WITH THE MERGER AT A PRICE OF $31.25 PER SHARE ? First, we must calculate the total cost of the merger. Total Cost of Merger = (Price per share x number of shares)+(Dividend Payment) = (31.25 x 8 million) + 67.5 million = 317,500,000 We then need to calculate expected synergies. We can do this by using the Weighed Average Cost of Capital: Dutton Golf WACC = (0.169*18/26)+(0.08*8/26)*(1-0.4) = 13.18% Elgin Golf WACC = (0.124*8/26)+(0.08*18/26)*(1-0.4) = 7.14% Expected Cash Flows for Dutton: Year 1: 20700000 Year 2: 20400000 Year 3: 25200000 Year 4: 31650000 Year 5: 37800000 Present Values of the expected cash flows: PV = (20700000/1.1318)+( 20400000/1.1318^2)+( 25200000/1.1318^3)+( 31650000/1.1318^4)+ ( 37800000/1.1318^5) =91238579 Expected synergies = PV of cash flows – total cost of merger = 91238579 - 317,500,000 = -226261420.8 The expected synergies are negative and therefore this merger should not proceed at a price of $31.25 per share.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

P ART II: W HAT IS THE HIGHEST PRICE PER SHARE THAT ELGIN SHOULD BE WILLING TO PAY FOR DUTTON ? We must first calculate the maximum price that would result in a synergy of zero. We know, from the previous question, that Synergies = PV of cash flows – total cost of the merger 0 = PV of cash flows – total cost of the merger Total cost of the merger = PV of cash flows 91238579 = (price per share *8million) + 67.5 million = $2.97 Therefore the highest price per share that Elgin should be willing to pay is $2.97. P ART III: W HAT EXCHANGE RATE WOULD MAKE THE MERGER TERMS EQUIVALENT TO THE ORIGINAL MERGER PRICE OF $31.25 PER SHARE ? First we should calculate how many Elgin shares would be exchanged for one Dutton share. Merger price = $31.25 Elgin’s Stock Price = $87 Exchange Ratio = 31.25/87 = 0.36 For every share of Dutton, Elgin will exchange 0.36 shares and this represents the exchange ratio that makes the terms equivalent to the original share price of $31.25. P ART IV: W HAT IS THE HIGHEST EXCHANGE RATIO ELGIN SHOULD BE WILLING TO PAY AND STILL UNDERTAKE THE MERGER ? The highest exchange ratio that Elgin should be willing to pay and still undertake the merger is the ratio at which Elgin shares would be exchanged for Dutton shares. This exchange ratio, calculated above, is 0.36 as it is the ratio of the merger price to Elgin’s stock price (31.25/87).

C ONCLUSION As discussed in the report above, at a share price of $31.25, the expected synergies are negative and therefore Elgin should not proceed with the merger. This indicates that the value of the merger is less than the value of the individual constituents and therefore this merger should not proceed. The present value of the cash flows are less than the total cost of the merger and therefore the merger should not proceed. The maximum price that Elgin should be willing to pay represents the share price at which the synergies are zero and the net present value of the cash flows are zero. This price is $2.97 (which is vastly different from the initial share price of $31.25) and is the maximum price Elgin should be willing to pay. In a stock exchange, the exchange rate that would make the merger terms equivalent to the original merger price of $31.25 is 0.36. This also represents the maximum ratio Elgin should be willing to pay and still undertake the merger as it represents a synergy of 0.