Hamilton Tourism, Inc., was in merger talks with Northern Park Company for the past six months. Now it is December 2015. After several rounds of negotiations, the offer under discussion is a cash offer of $300 million for Northern Park. Both companies have niche markets in the tourism industry, and both believe that a merger will result in synergies due to economies of scale in tourism and marketing, as well as significant savings in general and administrative expenses.

Peter Hansen, the financial officer for Hamilton Tourism, has been instrumental in the merger negotiations. Peter has prepared the following forecasts of financial statements in the next five years for Northern Park assuming the merger takes place. The financial statements include all synergistic benefits from the merger.

2016 Sales $ 360,000,000 Production costs 248,000,000 Other expenses 36,000,000 Depreciation 33,000,000 EBIT $ 43,000,000 Interest 8,500,000 Taxable income $ 34,500,000 Taxes (40%) 13,800,000 Net income $ 20,700,000 Additions to retained earnings 0

2017 Sales $ 405,000,000 Production costs 284,000,000 Other expenses 41,000,000 Depreciation 36,000,000 EBIT $ 44,000,000 Interest 10,000,000 Taxable income $ 34,000,000 Taxes (40%) 13,600,000 Net income $ 20,400,000 Additions to retained earnings $ 15,400,000

2018 Sales $ 450,000,000 Production costs 315,000,000 Other expenses 45,000,000 Depreciation 37,000,000 EBIT $ 53,000,000 Interest 11,000,000 Taxable income $ 42,000,000 Taxes (40%) 16,800,000 Net income $ 25,200,000 Additions to retained earnings $ 11,700,000

2019 Sales $ 508,500,000 Production costs 355,500,000 Other expenses 51,000,000 Depreciation 38,000,000 EBIT $ 64,000,000 Interest 11,250,000 Taxable income $ 52,750,000 Taxes (40%) 21,100,000 Net income $ 31,650,000 Additions to retained earnings $ 11,700,000

2020 Sales $ 562,500,000 Production costs 393,000,000 Other expenses 56,000,000 Depreciation 38,000,000 EBIT $ 75,500,000 Interest 12,500,000 Taxable income $ 63,000,000 Taxes (40%) 25,200,000 Net income $ 37,800,000 Additions to retained earnings $ 10,800,000

If Hamilton Tourism buys Northern Park, an immediate dividend of $100 million would be paid from Northern Park to Hamilton Manufacturing. Stock in Hamilton Tourism currently sells for $87 per share, and the company has 18 million shares of stock outstanding. Northern Park has 10 million shares of stock outstanding. Both companies can borrow at an 8 percent interest rate. Peter believes the current cost of capital Hamilton Tourism is 11 percent. The cost of capital for Northern Park is 12.4 percent, and the cost of equity is 16.9 percent. In five years, the value of Northern Park is expected to be $300 million after accounting for all the cash flows taking place after the fifth year.

Given the information above, help Peter to answer the questions below:

1. Suppose Northern Park shareholders will agree to a merger price of $30 per share. Should Hamilton Tourism proceed with the merger in terms of NPV?

Hints:

a. You can treat dividends per year (net income minus additions to retained earnings) from Northern Park in the table of forecasted financial statement as cash flows relating to 4 synergistic benefits of the merger each year. You can discount them and sum discounted dividends for calculation of NPV.

b. NPV of the merger = - costs incurred by the merger + discounted future synergistic benefits from merging with Northern Park + discounted terminal value of Northern Park.

c. Pay attention to the discounting rates for future cash flows.

2. What is the highest price per share that Hamilton Tourism should be willing to pay for Northern Park?

Hints: Highest offer = Costs incurred by the merger + NPV of the merger.