Question

Fly-By-Night Couriers is analyzing the possible acquisition of Flash-in-the-Pan Restaurants. Neither firm has debt. The forecasts of Fly-By-Night show that the purchase would increase its annual aftertax cash flow by $370,000 indefinitely. The current market value of Flash-in-the-Pan is $9 million. The current market value of Fly-By-Night is $23 million. The appropriate discount rate for the incremental cash flows is 8 percent. Fly-By-Night is trying to decide whether it should offer 35 percent of its stock or $13 million in cash to Flash-in-the-Pan.
a. What is the synergy from the merger?
b. What is the value of Flash-in-the-Pan to Fly-By-Night?
c. What is the cost to Fly-By-Night of each alternative?
d. What is the NPV to Fly-By-Night of each alternative?
e. Which alternative should Fly-By-Night use?

Answer 1

Answer:

Explanation:

a. The synergy will be the present value of the incremental cash flows of the proposed purchase.      

Since the cash flows are perpetual, this amount is $370,000/.08      

=$370000/.08        

=$4,625,000

b        

The value of Flash-in-the-Pan to Fly-by-Night is the synergy plus the current market value of Flash-in-the-Pan      

= $4625000+9000000          

=$13625000

c

stocked acquired = percentage age of ownership x value of merged firm

0.35 (13625000 + 23000000)

= $12818750

d

NPVs = Value of Flash-in-the-Pan to Fly-by-Night – (equivalent) cash offer =synergy – cost:    

NPV of cash alternative = 13625000 – 13000000 = $625,000

NPV of stock alternative = 13625000 - 12818750 = $806,250

e

Use the Stock Alternative, Because NPV is better