companies can borrow at an 8 percent interest rate. The risk-free rate is 6 percent, and the expected return on the market is 13 percent. Bryce believes the current cost of capital for Birdie Golf is 11 percent. The beta for Hybrid Golf stock at its current capital structure is 1.30. Bryce has asked you to analyze the financial aspects of the potential merger. Specifically, he has asked you to answer the following questions: 1. Suppose Hybrid shareholders will agree to a merger price of $63.25 per share. Should Birdie proceed with the merger? 2. What is the highest price per share that Birdie should be willing to pay for Hybrid? 3. Suppose Birdie is unwilling to pay cash for the merger but will consider a stock exchange. What exchange ratio would make the merger terms equivalent to the original merger price of $63.25 per share? 4. What is the highest exchange ratio Birdie would be willing to pay and still undertake the merger?
Transcribed Image Text:Birdie Golf, Inc., has been in merger talks with Hybrid Golf Company for the past six months.
After several rounds of negotiations, the offer under discussion is a cash offer of $352 million
for Hybrid Golf. Both companies have niche markets in the golf club industry, and the com-
panies believe a merger will result in significant synergies due to economies of scale in manu-
facturing and marketing, as well as significant savings in general and administrative expenses.
Bryce Bichon, the financial officer for Birdie, has been instrumental in the merger negotia-
tions. Bryce has prepared the following pro forma financial statements for Hybrid Golf assum-
ing the merger takes place. The financial statements include all synergistic benefits from the
merger:
2019
2020
2021
2022
2023
Sales
$409,600,000
$460,800,000 $512,000,000 $576,000,000 $640,000,000
Production costs 287,400,000 332,500,000 358,400,000 404,500,000 451,200,000
40,900,000 42,300,000 42,500,000 43,900,000
51,200,000 57,900,000
Depreciation
38,400,000
40,900,000 46,100,000
Other expenses
63,100,000
EBIT
Interest
9,730,000
11,260,000
$ 42,900,000 $ 51,300,000 $60,100,000 $ 71,100,000 $81,800,000
12,300,000 12,800,000 13,800,000
$33,170,000 $ 40,040,000 $ 47,800,000 $ 58,300,000 $ 68,000,000
10,0 10,000 11,950,000
Taxable income
Taxes (25%)
8,292,500
14,575,000
17,000,000
Net income $ 24,877,500 $ 30,030,000 $35,850,000 $ 43,725,000 $ 51,000,000
Transcribed Image Text:2019
2020
2021
2022
2023
Investments:
Net working capital $10,200,000 $12,800,000 $12,800,000 $15,400,000 $15,400,000
Fixed assets
7,700,000 13,800,000 9,300,000 31,400,000 3,900,000
$17,900,000 $26,600,000 $22,100,000 $46,800,000 $19,300,000
Total
Sources of
financing:
New debt
Profit retention
$17,900,000 $9,200,000 $8,200,000 $15,000,000 $ 6,100,000
O 17,400,000 13,900,000 31,800,000 13,200,000
$17,900,000 $26,600,000 $22,100,000 $46,800,000 $19,300,000
Total
The management of Birdie Golf feels that the capital structure at Hybrid Golf is not
optimal. If the merger takes place, Hybrid Golf will immediately increase its leverage with a
$57 million debt issue, which would be followed by a $76 million dividend payment to Birdie
Golf. This will increase Hybrid's debt-equity ratio from .50 to 1.00. Birdie Golf also will be
able to use a $12.8 million tax loss carryforward in both 2019 and 2020 from Hybrid Golf's
previous operations. The total value of Hybrid Golf is expected to be $460.8 million in five
years, and the company will have $153.6 million in debt at that time.
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