Fertfood has a current market value of $30 million and earns $2,700,000 annually

Question

Fertfood has a current market value of $30 million and earns $2,700,000 annually, while Tools-4U has a market value of $5 million and annual earnings of $1 million per year. If the companies merge an additional cash flow of $86986 would result next year, which is expected to grow at 2.8% per annum. The merged firm's weighted average cost of capital will be 8.9 percent and will have 11 million shares. If Fertfood pays $5,500,000 in cash for Tools-4U, what would be the net present value of the merger?

Explanation / Answer

Present value of additional cash flows using discount model,

PV = CF1 / (WACC – g)

PV = 86986 /(8.9%-2.8%)

PV = 1,426,000

Since Market value of Tools 4u is 5 Million and Fertfood have paid 5.5 million so net outflow is 0.5 Million or $500,000.

NPV of merger = PV of Addl. CF Less Net Outflow

= 1426000-500000

= $926,000

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