In Freedonia and Prisonia there are no taxes, and the capital markets are well-integrated across the two countries. Two multinational utility firms, FreeCorp and PriCorp, have WOSs that compete in the Prisonian market for electric power. Right now, the aggregate annual revenue of both producers is 1,050m/year, without any growth prospects. The current market value of FreeCorp's wholly owned subsidiary is 200m, while PriCorp's WOS is worth 100m. Both companies are fully equity-financed. FreeCorp and PriCorp are negotiating a merger of their Prisonian subsidiaries. This would stop competition and would allow the producers to increase the price of electric power by 10 percent. Total sales would drop slightly, to 1,000m/year, but the higher profit margin would lead to a JV with a market value of 400m.
(a) Assume initially that the newly formed JV would be a fully equity-financed firm (no bonds, royalties, management fees, etc.). The merchant bank that acts as the adviser proposes that, as FreeCorp's assets are currently worth 200m and PriCorp's assets 100m, FreeCorp should get two-thirds of the shares.
i. Evaluate this proposal: who gets how much of the synergy gains?
ii. Formulate a counterproposal if you disagree.
(b) The Prisonian Foreign Investment Act restricts the equity share of foreign owners to 50 percent at most.
i. How much of the synergy gain accrues to each parent if ( = 50 percent and if there is no other contract (like a license contract, for instance)?
ii. As a result of the above contract, what is the side payment that PriCorp must make to FreeCorp, one way or another, so that the gains are fairly shared?
(c) PriCorp proposes that FreeCorp receive an annual management fee of 0.5 percent of annual sales as payment for the accounting software contributed by FreeCorp. Given perpetual sales of 1,000m/year and a yield on perpetual bonds equal to 10 percent, the present value of this perpetual management fee is

However, the proposal is vague about whether the management fee is paid out by the JV or by PriCorp.
(1) From FreeCorp's point of view, does it make a difference whether the management fee is paid out by the JV or by PriCorp?
(2) If it makes a difference, evaluate the proposed management fee for each case, and formulate a counterproposal.

Transcribed Image Text:

0.5% x 1, 000m 10% :54m