Large plc is considering the takeover of Small plc. Large is currently valued at

Question

Large plc is considering the takeover of Small plc.
Large is currently valued at £60m on the stock market while Small is valued at £30m. The economies of scale and other benefits of the merger are expected to produces
a market value for the combined firm of £110m. A bid premium of £20m is expected to be needed to secure Small. Transaction costs (advisers' fee, etc.) are estimated at £3m.
Large has 30 million shares in issue and Small has 45 million. Assume that the managers are shareholder-wealth maximisers.

A. Does this merger create value for Large plc?

B. If the purchase is made with cash what will be the price offered for each of Small's shares?

C. What would be the value of each of Large's shares after this merger?

Explanation / Answer

This merger does not create value for Large PLC. This is because the expected value of the combined entity stands at 110 million. Their independent valuation is already at 90 million (60 + 30 million) and a bid premium of 20 million is required which already takes up the amount of money spent to 110 million. Add the 3 million of transaction costs and this proposal looks 3 million too costly. If the purchase was made in cash, then value of each of smalls shares would be 50 million / 45 million = 111.11 pence per share ignornig the transaction costs which we assume are being absorbed by Large PLC.

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