US Airlines and American Airways are stock market listed companies in the US. Their stock market data is the following:

US Airlines

American Airways

SHARE PRICE

$45

$10

NO. OF SHARES

5 million

2 million

MKT. CAP'N

$ 225 MILLION

$20 MILLION

Earnings

$30 MILLION

$0.1 MILLION

US Airlines announces a cash-bid to take over American Airways. The terms of the cash offer are the following

US Airlines takes over American Airways for $12.5 cash per share.

US Airlines estimates the synergistic benefits to be $5 million.

a. You are a stock analyst at a bank, covering the airline industry. As soon as the takeover announcement is made, your clients expect you to make a recommendation on whether the deal will be value enhancing or if it destroys wealth. Your task: you need to come up with the following estimates: (3 marks)

1. Net Cost to US Airlines.

2. NPV to US Airlines if the bid for American Airways is accepted at $12.5 per share.

3. What will be the price of US Airlines after the announcement (assuming no other changes)?

B) Assume now that US Airways decided to use scrip offer instead of cash offer. After long negotiations a 3:10 swap ratio was agreed on. Recalculate the net cost, NPV and the price of the combined firm after the merger.

c. Assume that all the synergy estimation is correct. Suggest two possible reasons why the merger between USAir and American Airlines took place?