Birdie Golf, Inc., has been in merger talks with Hybrid Golf Company for the past six months. After several rounds of negotiations, the offer under discussion is a cash offer of $155 million for Hybrid Golf. Both companies have niche markets in the golf club industry, and both believe that a merger will result in synergies due to economies of scale in manufacturing and marketing, as well as significant savings in general and administrative expenses.

Bryce Bichon, the financial officer for Birdie, has been instrumental in the merger negotiations. Bryce has the following pro forma financial statements for Hybrid Golf assuming the merger takes place. The financial statements include all synergistic benefits from the merger.

In millions 2022 2023 2024 2025 2026

Sales $264 $300 $332 $356 $396

Production costs 185 210 232.4 249.2 277.2

Other expenses 26.4 30.4 32.8 36 39.2

Depreciation 21.6 24.8 26.4 28.7 28.8

EBIT 31 34.8 40.4 42.1 50.8

Interest 6 7.2 8 8.4 8.8

Taxable income 25 27.6 32.4 33.7 42

Taxes (21%) 5.25 5.796 6.804 7.077 8.820

Net income 19.75 21.804 25.596 26.623 33.180

Additions

to retained earnings 0 12.8 15 17 20

If Birdie Golf buys Hybrid Golf, an immediate dividend of $45 million would be paid from Hybrid Golf to Birdie. Stock in Birdie Golf currently sells for $71 per share, and the company

has 14 million shares of stock outstanding. Hybrid Golf has 6.4 million shares of stock outstanding. Both companies can borrow at an 8 percent interest rate. Bryce believes the current cost of capital for Birdie Golf is 11 percent. The cost of capital for Hybrid Golf is 12.4 percent, and the cost of equity is 16.9 percent. In five years, the value of Hybrid Golf is expected to be $190 million.

Bryce has asked you to analyze the financial aspects of the potential merger. Specifically, he has asked you to answer the following questions.

QUESTIONS

1a. Suppose Hybrid shareholders will agree to a merger price of $24.22 per share. Should Birdie proceed with the merger?

1b. What is the highest price per share that Birdie should be willing to pay for Hybrid?

1c. Suppose Birdie 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 $24.22 per share?

1d. What is the highest exchange ratio Birdie should be willing to pay and still undertake the merger?