Question
Your firm, Goldmine Incorporated, is considering the purchase of a technology firm called Techworks. The purchase would result in a merged firm named GoldTech. Goldmine
Your firm, Goldmine Incorporated, is considering the purchase of a technology firm called Techworks. The purchase would result in a merged firm named GoldTech. Goldmine is considering this purchase because operating synergies with Techworks would result in total cash flows that are greater than the sum of the cash flows from the two companies if they operated separately.
The following table outlines the possible cash flows produced by Goldmine and Techworks each year if they operated as solo businesses, and the possible cash flows produced by Goldmine and Techworks if they combined forces under the GoldTech name:
The expected return on Goldmine cash flows is 10 percent, and the expected return on Techworks cash flows is 16 percent. If the firms combined forces as GoldTech, then the expected return on GoldTech cash flows would be 11.5%. Both firms are all-equity and will operate in perpetuity. Each standalone firm has 10M shares outstanding.
a) Assume that no merger announcement has been made. What are the share prices for Goldmine and Techworks? (You can ignore the GoldTech cash flows for this question.)
Goldmine announces it will purchase all of the shares of Techworks and pay a premium of 25% on the Techworks share price that you calculated in part (a). This will be a stock-for-stock merger. That is, Goldmine will issue shares of its own firm and exchange them for shares in Techworks. The exchange will be based on the Goldmine share price and value of Techworks with the 25% premium. Assume that the Goldmine share price does not change following the announcement.
b) What percentage of Goldmine has to be sold in order to acquire all of the shares in Techworks? (Hint: to determine the number of shares that Goldmine has to sell, calculate the total dollar cost of purchasing all of the Techworks shares with the 25% premium, and then divide the total dollar cost by the share price of Goldmine that you calculated in part (a).)
c) Is the merger a good idea? (Hint: compare the value created from the merger to the cost of the merger. The value created from the merger is the value of GoldTech minus the values of Goldmine and Techworks as solo firms. The cost of the merger is the total dollar cost of purchasing all of the Techworks shares with the 25% premium minus the total dollar cost of purchasing all of the Techworks shares without the 25% premium.)
d) What is the share price of GoldTech after the merger is completed, and how does it compare to the Goldmine share price prior to the merger? Keep in mind that the number of shares outstanding for GoldTech will now equal the original 10M shares of Goldmine plus the shares issued in part (b).
\begin{tabular}{|l|c|c|} \hline & State A & State B \\ \hline Probability & 40% & 60% \\ \hline Goldmine Cash Flow (solo) & $40M & $80M \\ \hline Techworks Cash Flow (solo) & $50M & $40M \\ \hline GoldTech Cash Flow (merged) & $100M & $135M \\ \hline \end{tabular}Step by Step Solution
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