\"border: 0px; height: 0px; margin: 0px; padding: 0px; width: 707px\"> Alpha Co.

Question

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Alpha Co. is about to make a tender

offer for all of Beta Company’s shares. Alpha is

an all equity

firm with one million shares

outstanding. These shares currently trade at $50.

The average cost of capital for Alpha

is 15%, and its P/E ratio is 12. Beta Company has a market value of

market value of ten million, and is currently half debt. The debt

is perpetual, has a face value of six million, and is currently

selling to yield 14%. It is estimated that if Alpha acquires Beta,

the rating of the debt would increase to Aa (12% yield). The P/E

ratio for Beta is 8. Beta Co. produces an all-equity cash

flow of two million per year  net of

investments. Under Beta’s management, this cash

flow is expected to be maintained indefinitely. Under

Alpha’s more aggressive management, the annual

cash flow would be increased by 15%

a. What is your estimate of synergy for

this merger?

b. If Beta has one million shares, what

is the maximum cash price which can be

offered?

c. What is the maximum exchange ratio

Alpha can offer?

Explanation / Answer

a) PV(CFAlone + CFSynergies) = PV(CFAlone) + PV(CFSynergies)

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