Page 917 - 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 $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: 2019 2020 2021 2022 2023 Sales $409,600,000 $460,800,000 $512.000.000 $576,000,000 $640,000,000 Production costs 287.400,000 332,500,000 358.400.000 404 500,000 451,200.000 Depreciation 38.400,000 40.900.000 42,300.000 42.500.000 43,900.000 Other expenses 40.900.000 46,100.000 51.200.000 57,900.000 63.100.000 $ 42,900.000 $ 51,300,000 $ 60,100,000 $ 71,100,000 EBIT $ 81,800,000 9.730,000 11.260.000 12.300.000 Interest 12.800.000 13.800,000 ed59da914209009:18 600XD2F10 2019 2020 2021 Sales 2022 2023 $409,600,000 $460,800,000 $512,000,000 Production costs $576.000.000 $640,000,000 287,400.000 332,500,000 358,400.000 404.500.000 451,200,000 Depreciation 38,400.000 40,900,000 42,300,000 43.900.000 Other expenses 40,900,000 46.100,000 42,500,000 57,900,000 51,200,000 63.100.000 EBIT $ 42,900,000 $ 51,300,000 $ 60,100,000 $ 71,100,000 $ 81,800,000 Interest 9.730.000 11.260.000 12,300,000 12,800,000 13,800,000 Taxable income $ 33,170,000 $ 40,040,000 $ 47,800,000 $ 58,300,000 $ 68,000,000 Taxes (25%) 8,292,500 10,010,000 11.950.000 14.575.000 17.000.000 Net income $ 24.877,500 $ 30,030,000 $ 35,850,000 $ 43.725.000 $ 51,000,000 ryce also is aware that the Hybrid Golf division will require investments each year for continuing operations, along with ources of financing. The following table outlines the required investments and sources of financing 2019 2020 2021 2022 2023 Investments: Net working capital $10,200,000 $12,800,000 $12,800,000 $15,400,000 $15,400,000 7,700,000 9,300,000 3,900,000 13,800,000 31.400,000 Fixed assets 2019 2020 2021 2022 2023 Investments: Net working capital Fixed assets $10,200,000 $12.800,000 $12.800,000 $15.400,000 $15.400.000 7.700.000 13.800.000 9,300,000 31,400,000 3,900.000 $17.900,000 $26,600,000 $22,100,000 $46,800,000 $19,300.000 Total Sources of financing: New debt $17.900.000 $ 9,200,000 $ 8,200,000 $15.000.000 $ 6.100.000 Profit retention 0 17,400,000 13.900.000 31.800.000 13.200,000 Total $17.900,000 $26,600,000 $22,100,000 $46,800,000 $19.300.000 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 $57 million debt issue, which would be followed by a $76 million dividend payment to Birdie Golf. This will increase Hybrid's debt-equity ratio from 50 to 1.00. Birdie Golf also will be able to use a $12.8 million tax loss carryforward in both 2019 and 2020 from Hybrid Golf's previous operations. The total value of Hybrid Golf is expected to be $460.8 million in five years, and the company will have $153.6 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. 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 $57 million debt issue, which would be followed by a $76 million dividend payment to Birdie Golf. This will increase Hybrid's debt-equity ratio from 50 to 100. Birdic Golf also will be able to use a $12.8 million tax loss carryforward in both 2019 and 2020 from Hybrid Golf's previous operations. The total value of Hybrid Golf is expected to be $460.8 million in five years, and the company will have $153.6 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 Page 918 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: 1. Suppose Hybrid shareholders will agree to a merger price of $63.25 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 $63.25 per share? 4. What is the highest exchange ratio Birdie would be willing to pay and still undertake the merger