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Part of the question –
It is thought that combining the two companies will result in several benefits. Free cash flows to firm
of the combined company will be $216 million in current value terms, but these will increase by an
annual growth rate of 5% for the next 4 years, before reverting to an annual growth rate of 2.25% in
perpetuity. In addition to this, combining the companies will result in cash synergy benefits of
$20 million per year, for the next 4 years. These synergy benefits are not subject to any inflationary
increase and no synergy benefits will occur after the fourth year. The debt to equity ratio of the
combined company will be 40:60 in market value terms and it is expected that the combined
company’s cost of debt will be 4.55%.Part of Answer
Total PV of cash flows (Years 5 to perpetuity) = 262.55 × 1.0225/(0.09 – 0.0225) × (1.09
to the power of – 4) = $2,817.51 millionCan you explain how to find the perpetuity value in a easier way ? If there is no lther way could you please explain this one.
One Makonis Co share for two Nuvola Co shares implies a premium of $0.50 ([$5.80 –
$4.80]/2) per Nuvola Co share.
If a 30% premium is offered to Nuvola Co’s equity holders, then they will expect $144 million
premium or $0.72 per share, and therefore the cash paid will be $0.22 for each Nuvola Co
share or $44 million in total.
If a 50% premium is offered to Nuvola Co’s equity holders, then they will expect $240 million
premium or $1.20 per share, and therefore the cash paid will be $0.70 per Nuvola Co share
or $140 million in total.Also could you please explain how we got 4.8 and 0.72 and 1.20 figures.
Please don’t type out past exam questions, because they are copyright of the ACCA. I have all the past exam questions and so you just need to say the name of the question and the date of the exam 🙂
When discounting an inflating perpetuity we use the dividend growth formula. In the same way that the formula gives the MV of shares by calculating the PV of growing dividends in perpetuity, we can use the same formula on cash flows instead of dividends to get the PV of an inflating stream in perpetuity. In this question, the perpetuity starts at time 5. The formula is if it starts at time 1, so when it is 4 years late (time 5 instead of time 1) we need to discount the answer for 4 years.
$4.8 is the value of 2 shares in Nuvola (2 x $2.40 = $4.80)
$0.72 = $144/200 (there are 200 m shares in Nuvola).
$1.20 = $240/200 (again, there are 200 m shares in Nuvola)
$44 M = 200 m shares x $0.22
$140 M = 200m shares x $0.70
Sir, if Makonis share for share exchange is 2 for 1, it means they are giving them 100 shares (200/2*1) but how do we determine the value of the share on which we are giving them? Would it stay 5.8? I understood the premium we have to pay and all but I want to know if I acquire a company through share exchange, how do I determine how much I am paying for 1 share of the company. In this question they took $5.8 I believe but I am confused.
When Nuvola’s shareholders are considering the offer from Makonis, they will be basing their decision on the current share price of Makonis (they do not know what will happen to the share price after the acquisition because they do not have the information that Makonis has).
Therefore, given that they are receiving 1 share (currently worth $5.80) for every 2 shares in Nuvola (which are currently worth $2.40 per share) they will be getting a payment of 5.80 – (2 x 2.40) = $1.00 for every 2 shares, so $0.50 per existing share, together with the cash payment.
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