ABC Inc., which has 1.5 m shares outstanding, wishes to merge with Fruity Drink with 2.5 million shares outstanding. The market prices for ABC and Fruity are $45 and $18 per share, respectively. The merger would create an estimated savings of $800k annually for the indefinite future. ABC has agreed to pay $22.50 per share of Fruity, and appropriate cost of capital for ABC is 14%.

a. Calculate the synergy if these firms merge. What are the sources of synergy in general? Explain them briefly from the formula of incremental cash flow.

b. What is the cost of the cash offer? Calculate the gain accrued to the shareholders of Fruity.

c. Calculate the NPV of the offer.

d. What is the maximum price ABC should offer?

e. If they agree to exchange stocks, find the NPV of the offer. Make comments in the change of the of the NPV.

f. Which method, cash or stock exchange, is better for the acquiring firm?