Question 2

Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $500,000 per year in perpetuity on an after-tax basis. Velcro Saddles can either pay $14 million cash for Pogo or offer Pogo a 50% stake in Velcro Saddles. The opportunity cost of capital is 10%.

a. What is the synergy from the merger?

b. What is the premium paid under the cash offer?

c. What is the premium paid under the stock alternative?

d. What is the NPV of the acquisition under the cash offer?

e. What is its NPV under the stock offer?

f. What is the percent of ownership that Velcro Saddles should offer if it wanted to pay exactly $14 million in stock for the acquisition?