Wasabi is contemplating purchase of Haiku. The market value of the 2 companies a
ID: 2620608 • Letter: W
Question
Wasabi is contemplating purchase of Haiku. The market value of the 2 companies are RM20 billion and RM11 billion, respectively. Wasabi thinks that the combined companies can cut operating costs by RM450 million per year, in perpetuity. Wasabi thinks that a successful cash bid will probably cost RM14 billion. It is also considering offering Haiku shareholders a 33% in the merged firm. Suppose the cost of cost of capital is 11%.
(a) What is the NPV to Wasabi? How does the NPV depend on whether the offer is for cash or stock? Should Wasabi go ahead?
(b) Could a decision to offer stock instead of cash for Haiku signal a lack of confidence by Wasabi’s managers in the stock-market valuation of their company? How would this affect the choice of financing and the odds of a successful transaction?
Explanation / Answer
Ans;
a)Value of target company=Market value of the target company + incremental cashflow generated due to merger
=RM11 Billions + RM150 Millions/0.11
=RM11 Billions + RM 4.091 Billions
=RM 15.091 Billions
Cash cost is the amount of cash offered i.e RM14 billion
cost of stock offer=The cost of the stock offer is the percentage of the acquiring firm given up times the sum of the market value of the acquiring firm and the value of the target firm to the acquiring firm. So, the equity cost will be:
=0.33x(RM 20 Billion + RM15.091 Billion)=RM 11.58 Billions
The NPV of each offer is the value of the target firm to the acquiring firm minus the cost of acquisition, so:
NPV Cash( Amount in Billion)= 15.091-14= 1.091
NPV Stock( Amount in Billion)=15.091 - 11.58=3.51
Since the NPV is greater with stock offer, Wasabi should go ahead with stock offer
b)By issuing shares,an acquirer in essence offers to share the newly merged company with the stockholders of the acquired company--a signal as a lack of confidence in the value of the acquirer's stock because it requires the selling stockholders to share the risk that the value of the acquirer's stock will decline before the deal goes through.
Whereas offering cash places all the potential risks and rewards with the acquirer--and sends a strong signal to the markets that it has confidence in the value not only of the deal but in its own stock.
Hence a decision to offer stock instead of cash for haiku does signal a lack of confidence by Wasabi’s managers in the stock-market valuation of their company.
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