Dave’s Pizza – Fulton Pizza Merger Dave’s pizza is considering a merger with Ful
ID: 2817584 • Letter: D
Question
Dave’s Pizza – Fulton Pizza Merger
Dave’s pizza is considering a merger with Fulton Pizza. The offer under discussion is a cash offer of $352 million for Fulton Pizza. Both companies have niche markets in the pizza industry, and the companies believe a merger will result in significant synergies due to economies of scale in manufacturing and marketing, as well as significant savings in general and administrative expenses.
Matt Robinson, the financial officer for Dave’s, has been instrumental in the merger negotiations. Matt has prepared the following pro forma financial statements for Fulton assuming the merger takes place. The financial statements include all synergistic benefits from the merger:
2015
2016
2017
2018
2019
Sales
$512,000,000
$576,000,000
$640,000,000
$720,000,000
$800,000,000
Production costs
359,200,000
403,200,000
448,000,000
505,600,000
564,000,000
Depreciation
48,000,000
51,200,000
52,800,000
53,120,000
53,600,000
Other expenses
51,200,000
57,600,000
64,000,000
72,320,000
77,600,000
EBIT
$ 53,600,000
$ 64,000,000
$ 75,200,000
$ 88,960,000
$104,800,000
Interest
12,160,000
14,080,000
15,360,000
16,000,000
17,280,000
Taxable Income
$ 41,440,000
$ 49,920,000
$ 59,840,000
$ 72,960,000
$ 87,520,000
Taxes @40%
16,576,000
19,968,000
23,936,000
29,184,000
35,008,000
Net Income
$ 24,864,000
$ 29,952,000
$ 35,904,000
$ 43,776,000
$ 52,512,000
Matt knows that Fulton will require investments each year for maintenance of plant. The table below has required investments and sources of financing:
2015
2016
2017
2018
2019
Investments
Net working capital
$ 12,800,000
$ 16,000,000
$16,000,000
$19,200,000
$19,200,000
Fixed assets
9,600,000
16,000,000
11,520,000
76,800,000
4,480,000
Total
22,400,000
$ 32,000,000
$ 27,520,000
$ 96,000,000
$ 23,680,000
Sources of financing
New debt
$ 22,400,000
$ 10,240,000
$ 10,240,000
$ 9,600,000
$ 7,680,000
Profit retention
0
21,760,000
17,280,000
17,280,000
16,000,000
Total
22,400,000
32,000,000
27,520,000
26,880,000
23,680,000
The management of Dave’s feels that that capital structure at Fulton is not optimal. If the merger takes place, Fulton will immediately increase its leverage with a $71 million debt issue, which would be followed by a $96 million dividend payment to Dave’s. This will increase Fulton’s debt-to-equity ratio from 0.50 to 1.00. Dave’s will also be able to use a $16 million tax loss carryforward in 2016 and 2017 from Fulton’s previous operations. The total value of Fulton is expected to be $576 million in five years, and the company will have $192 million in debt at that time.
Stock in Dave’s currently sells for $94 per share, and the company has 11.6 million shares of stock outstanding. Fulton has 5.2 million shares of stock outstanding. Both companies can borrow at 8%. The risk-free rate is 6%, and the expected return on the market is 13%. Matt believes the current cost of capital for Dave’s is 11%. The beta for Fulton at its current capital structure is 1.30.
Matt has asked you to analyze the financial aspects of the potential merger. Specifically, he has asked you to answer the following questions:
1. Suppose Fulton’s shareholders will agree to a merger price of $68.75 per share. Should Dave’s proceed with the merger?
2. What is the highest price per share that Dave’s should be willing to pay for Fulton?
3. Suppose Dave’s is unwilling to pay cash for the merger but will consider a stock exchange. What exchange ratio would make the merger terms equivalent to the original merger price of $68.75 per share?
4. What is the highest exchange ratio Dave’s would be willing to pay and still undertake the merger?
2015
2016
2017
2018
2019
Sales
$512,000,000
$576,000,000
$640,000,000
$720,000,000
$800,000,000
Production costs
359,200,000
403,200,000
448,000,000
505,600,000
564,000,000
Depreciation
48,000,000
51,200,000
52,800,000
53,120,000
53,600,000
Other expenses
51,200,000
57,600,000
64,000,000
72,320,000
77,600,000
EBIT
$ 53,600,000
$ 64,000,000
$ 75,200,000
$ 88,960,000
$104,800,000
Interest
12,160,000
14,080,000
15,360,000
16,000,000
17,280,000
Taxable Income
$ 41,440,000
$ 49,920,000
$ 59,840,000
$ 72,960,000
$ 87,520,000
Taxes @40%
16,576,000
19,968,000
23,936,000
29,184,000
35,008,000
Net Income
$ 24,864,000
$ 29,952,000
$ 35,904,000
$ 43,776,000
$ 52,512,000
Explanation / Answer
Before any merger and acquisition the following facotrs must be considered:-
a) Understanding the strength and weakness of each company
b) Determining the viability of potential mergers and acquisitions.
c) Big companies with large balance sheets and little debts make an attractive partner and vice versa.
d) Work force factors
e) Merger and acquisition motivation where both buyer and seller are important.
This case study is related to merger and acquisition , the above paragraph briefs about the factors to be considered for merger and acquisition.
Case Study Analysis :-
1. No, It should not proceed for a merger because debt portion is very high.
2. The highest price dave is going to pay per share will be $94 per share.
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