Your firm, Goldmine Incorporated, is considering the purchase of a technology fi
ID: 2716804 • Letter: Y
Question
Your firm, Goldmine Incorporated, is considering the purchase of a technology firm called Techworks. The reason that your firm is considering this purchase is that when Goldmine has a bad year, Techworks tends to have a good year. Thus, Goldmine will not have cash flow problems in its bad years because Techworks would produce high cash flows in those years.
Specifically, one of three states can occur every year. Here are the cash flows produced by each firm within each state:
assume that the Goldmine cash flow in State A will be $15M lower because of the negative feedback effects resulting from the cash flow problems. If Goldmine purchases Techworks, then Goldmine will not incur this $15M cost in State A.
Assume that the annual expected return on Goldmine assets is 10 percent and the expected return on Techworks assets is 12.5 percent. Both firms are all-equity and will operate in perpetuity. Each firm has 10M shares outstanding.
a) First assume that no merger announcement has been made yet. What is the price per share of each firm?
Goldmine announces that it will purchase all of the shares in Techworks and pay a premium of 20 percent on the Techworks share price that you calculated in part (a). This will be a stock-for-stock merger. That is, Goldmine will issue shares in its own firm and exchange them for shares in Techworks (the exchange will be based on the value of Goldcorp shares from (a) relative to the value of Techworks shares with the 20 percent premium).
b) What percentage of Goldcorp will have to be sold in order to acquire all of the shares in Techworks?
c) What is the value of the combined firm?
d) Is the merger a good idea? For this, you will have to compare the value created from the merger to its cost.
e) What is the share price of Goldcorp after it purchases Techworks? Compare this to the price per share calculated for Goldcorp in part (a).
state A State B State C Probability 30% 40% 30% Goldmine cash flow $20M $60M $100M Techwork cash flow $50M $40M $30MExplanation / Answer
a) First assume that no merger announcement has been made yet. What is the price per share of each firm?
Answer:
The price per share of each firm :
Goldmine:
Total cash flows = 0.3x20 + 0.4x60 + 0.3x100 = $48 million
Net cash flows = $48 million – cost because of negative feedback
NCF = $48 million - $15 million = $33 million.
Expected return = 10%
So the value of firm = $33 million / 10% = $330 million
Number of shares outstanding = 10 million
So price of each share = $330/10 = $33 per share
Techworks:
Total cash flows = 0.3x50 + 0.4x40 + 0.3x30 = $40 million
Net cash flows = $40 million
Expected return = 12.5%
So the value of firm = $40 million / 12.5% = $320 million
Number of shares outstanding = 10 million
So price of each share = $320/10 = $32 per share
Goldmine announces that it will purchase all of the shares in Techworks and pay a premium of 20 percent on the Techworks share price that you calculated in part (a). This will be a stock-for-stock merger. That is, Goldmine will issue shares in its own firm and exchange them for shares in Techworks (the exchange will be based on the value of Goldcorp shares from (a) relative to the value of Techworks shares with the 20 percent premium).
Answer: Total Value of Techworks before merger = $320 million
And share price = $32
After 20% premium the share would be = $32x(1+20%) = $38.4
So number of shares to be issued by Goldcorp = $320million/$38.4
number of shares to be issued by Goldcorp = 8.33 million
Total value of these shares $320 million
Now value of Goldcorp = $330 million
So percentage to be sold = $320 million / $330million
So percentage to be sold = 96.96%
Value of combined firm = 330 + 320 = 650 million
Answer: Value of per share of combined firm = $650 million / 18.33 = $35.46
Which is higher than the value of the firms separately. So the merger is a good idea.
e) What is the share price of Goldcorp after it purchases Techworks? Compare this to the price per share calculated for Goldcorp in part (a).
Answer: Value of per share of combined firm = $650 million / 18.33 = $35.46
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