Aussie Ltd is thinking of acquiring Kiwi Ltd. The current market value of Aussie Ltd is $20 million, whereas Kiwis market value is $10 million. Each firm has no debt and 2 million shares outstanding. Aussie estimates that by combining the two companies, it will reduce selling and administrative costs by $150,000 per annum in perpetuity with no change in risk.

Aussie is considering a cash offer of $5.50 per share for Kiwi or a share swap of one Aussie share for two Kiwi shares.

1. Assume the cost of capital for synergies is 10% p.a. What is the total gain, in present value terms, from the merger?

2. If the cash offer is made, how much of the gain goes to the shareholders of Kiwi Ltd and how much goes to the shareholders of Aussie Ltd?

3. If Aussie Ltd offers the share swap, what will be the new share price of the combined firm?