Part A (12 marks) Firm Z has a current market value of $35 million and is considering the acquisition of firm Y, whose current market value is $20 million. Both firms are all-equity. A market research study by the investment bank hired by firm Z shows that a purchase of firm Y will increase the after-tax cash flows of Y by $600,000 in perpetuity. The appropriate discount rate for the incremental cash flow is 8%. a) What is the value of firm Y to firm Z? (5 marks) b) Firm Z is trying to decide whether to offer 25% of its own stocks or $21 million cash to shareholders of firm Y. If you were a shareholder of firm Z, which method of payment would you prefer for the acquisition of firm Y and why? (7 marks) Part B (18 marks) On January 10, 2000 AOL announced the acquisition of Time Warner (TWX), in which 1.5 shares of AOL were exchanged for 1 share of TWX. The table below describes the pre-merger values: AOL TWX Share Price $72.88 $64.75 Number of Shares Market Cap (pre-merger) 2.6 billion 1.4 billion $189.5 billion $90.7 billion a) What was the % ownership split of shareholders after the transaction? (3 marks) b) What are some of the reasons AOL might want to acquire Time Warner? (3 marks) c) Assume that there are no synergies between the two firms. What was the percentage premium that TWX shareholders received? How much would AOL have to pay for TWX in cash such that shareholders of TWX would be indifferent between a share or cash acquisition? (5 marks) d) On July 18, 2002, the stock price (of the combined company) was $12.75. How much value was created since the acquisition of TWX? How is the value creation or destruction shared between the (former) shareholders of AOL and the (former) shareholders of TWX? What if alternatively AOL had bought TWX using cash? (5 marks) e) Looking back, would the (former) shareholders of TWX have preferred a stock or a cash acquisition in (d)? (2 marks)