Here's the question: The Birdie Golf?Hybrid Golf Merger 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 $550 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 prepared the following pro forma financial statements for Hybrid Golf assuming the merger takes place. The financial statements include all synergistic benefits from the merger. If Birdie Golf buys Hybrid Golf, an immediate dividend of $75 million would be paid from Hybrid Golf to Birdie. Stock in Birdie Golf currently sells for $94 per share, and the company has 18 million shares of stock outstanding. Hybrid Golf has 8 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 $300 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 Suppose Hybrid shareholders will agree to a merger price of $43.75 per share. Should Birdie proceed with the merger? What is the highest price per share that Birdie should be willing to pay for Hybrid? 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 $43.75 per share? What is the highest exchange ratio Birdie should be willing to pay and still undertake the merger?

Chapter 26 The Birdie Golf-Hybrid Golf Merger Input Area: Cash offer $ Sales Production costs Other expenses Depreciation EBIT Interest Taxable income Taxes (40%) Net income $ Additions to retained earnings $ $ 2012 400,000,000 276,000,000 40,000,000 37,000,000 47,000,000 9,500,000 37,500,000 15,000,000 22,500,000 $ Dividends from Hybrid today Stock price of acquirer Shares outstanding in acquirer Shares outstanding in target Borrowing rate Hybrid WACC Hybrid cost of equity Terminal value of Hybrid in five years 350,000,000 $ $ $ $ Tax rate $ $ $ $ - $ 2013 450,000,000 315,000,000 45,000,000 40,000,000 50,000,000 11,000,000 39,000,000 15,600,000 23,400,000 $ $ $ $ 17,000,000 $ 2014 500,000,000 350,000,000 50,000,000 41,000,000 59,000,000 12,000,000 47,000,000 18,800,000 28,200,000 $ $ $ $ 13,000,000 $ 2015 565,000,000 395,000,000 57,000,000 42,000,000 71,000,000 12,500,000 58,500,000 23,400,000 35,100,000 $ 2016 625,000,000 437,000,000 62,000,000 43,000,000 83,000,000 13,500,000 69,500,000 27,800,000 41,700,000 13,000,000 $ 12,000,000 $ $ $ 75,000,000 94.00 18,000,000 8,000,000 8% 12.40% 16.90% 300,000,000 40% Output Area: Acquisition of Hybrid Dividends from Hybrid Terminal value of company Total Present values Acquisition of Hybrid Dividends from Hybrid Terminal value of company Total 1) NPV 2) Highest price to offer Price per share offered Highest share price to offer 3) New share price Exchange ratio 4) Highest exchange ratio $ Year 0 (350,000,000) Year 1 Year 2 Year 3 Year 4 Year 5 Dividends P Calculate P $ - $ - $ - $ - $ - $ - Paid = Net Income - Addition to Retained Earnings PV using discount rate of cost of equity