THE BIRDIE GOLF's and HYBRID GOLF MERGER (3000 points + a bonus 1000! I'm new, and need to figure out how to post more to total 4000 points.)

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 $352 million for Hybrid Golf. Both companies have niche markets in the golf club industry, and the companies believe a merger will result in significant 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:

2012... 2013... 2014... 2015... 2016

Sales 512,000,000 576,000,000 640,000,000 720,000,000 800,000,000

Production costs 359,200,000 403,200,000 448,000,000 505,600,000 564,000,000

Depreciation 48,000,000 51,200,000 52,800,000 53,120,000 53,600,000

Other expenses 51,200,000 57,600,000 64,000,000 72,320,000 77,600,000

EBIT 53,600,000 64,000,000 75,200,000 88,960,000 104,800,000

Interest 12,160,000 14,080,000 15,360,000 16,000,000 17,280,000

Taxable income 41,440,000 49,920,000 59,840,000 72,960,000 87,520,000

Taxes (40%) 16,576,000 19,968,000 23,936,000 29,184,000 35,008,000

Net income 24,864,000 29,952,000 35,904,000 43,776,000 52,512,000

Bryce is also aware that the Hybrid Golf division will require investments each year for continuing operations, along with sources of financing. The following table outlines the required investments and sources of financing:

2012 2013 2014 2015 2016

Investments:

Net working capital 12,800,000 16,000,000 16,000,000 19,200,000 19,200,000

Fixed assets 9,600,000 16,000,000 11,520,000 76,800,000 4,480,000

Total 22,400,000 32,000,000 27,520,000 96,000,000 23,680,000

Sources of financing:

New debt 22,400,000 10,240,000 10,240,000 9,600,000 7,680,000

Profit retention 0 21,760,000 17,280,000 17,280,000 16,000,000

Total 22,400,000 32,000,000 27,520,000 26,880,000 23,680,000

The management of Birdie Golf feels that the capital structure at Hybrid Golf is not optimal. If the merger takes place, Hybrid Golf will immediately increase its leverage with a $71 million debt issue, which would be followed by a $96 million dividend payment to Birdie Golf. This will increase Hybrida's debt-to-equity ratio from .50 to 1.00. Birdie Golf will also be able to use a $16 million tax loss carry forward in 2013 and 2014 from Hybrid Golf's previous operations. The total value of Hybrid Golf is expected to be $576 million in five years, and the company will have $192 million in debt at that time.

Stock in Birdie Golf currently sells for $94 per share, and the company has 11.6 million shares of stock outstanding. Hybrid Golf has 5.2 million shares of stock outstanding.

Both companies can borrow at an 8 percent interest rate. The risk-free rate is 6 percent, and the expected return on the market is 13 percent. Bryce believes the current cost of capital for Birdie Golf is 11 percent. The beta for Hybrid Golf stock at its current capital structure is 1.30.

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

Note from Backbeat: The answers to the following questions need to be written out, so I can figure out what and how you arrived at the solution. I will want to construct an Excel Spreadsheet, so your narrative will be most helpful.

Which by the way, I will pay an extra 1000 points for a clean Excel Spreadsheet (as soon as I figure it out).

1. Suppose Hybrid shareholders will agree to a merger price of $68.75 per share. Should Birdie proceed with the merger?

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

3. 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 $68.75 per share?

4. What is the highest exchange ratio Birdie would be willing to pay and still undertake the merger?