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When finding the benefit to Pursuit sharholders (the predator) the solution of the exam question is:
1. find the synergy benefit of the acquisiton calculated as: the total firm value of combined less value of the two firms;.
2 from the synergy is deducting the premium of the acquistion.But I do not understand why the benefit for the sharholders of the predator is not simple the difference between the initial market equity value of combined less the market equity value of predator (as the consideration for acquistion does not involve issuing new share)??
I am very confused why we take the total value of the firm as the shareholders wealth it related only to the equity value. In this case if combined company has a total value 189 mil and debt to equity is 50:50 the sharholders wealth is about 90 m compare to 70m equity market value in Pursuit, so they gain 20m (the answer in the exam gives a net benefit of only 52.000$ very different….)
Thank you again Sir!
But you are trying to find the benefit to Pursuit shareholders.
Some of the benefit goes to the old shareholders of Fodder (because they are taken over at a premium). What you are trying to do is calculate the total benefit to both Pursuit and Fodder’s shareholders.The question asks “whether the acquisition of F’Co would be beneficial to P’Co and its shareholders”
Given that the shareholders own P’Co then it really means the shareholders as there can be no change in the debt holders value – their loans are unchanged.
So what I can’t understand is that the solution compares the Value of Firms – P’Co & F’C when it should be comparing Equity Values (I think?)
For example
P’Co’s pre-acq Equity Value is $70m. It pays $49m for E & D values of F’Co which is now all equity. So its ‘cost’ of combination is $119m
Compared to its combined equity value (given that the Ke was calculated using 50:50 gearing) is 50% of $189 = $95k. It would seem to me that P’Co’s shareholders have lost (95 – 119) $24m
Please help!The reason is that any gain in the total market value goes to shareholders (not to debt).
Keeping the gearing the same may mean raising more debt, but raising more debt finance does not change the actual value of the firm overall because raising debt means they have more assets (cash) and at the same time more liabilities (the debt).
“The reason is that any gain in the total market value goes to shareholders (not to debt)”
I’m not sure I agree/understand – surely if debt holders put more funds into the company, then the increase in market value (value of firm debt + equity) belongs to debt holders.
In this case the question doesn’t say what the debt holders put in but their proportion post acquisition is 50% of the actual value of the firm which suggest they put in (95-70) $25 extra funds – the other 50% is owned by the equity holders.
Alternatively, how can the debt holders have the same proportion (50:50 market values) of a much larger entity without increasing their value?
This is why I can’t understand why comparing; Value of Firm with Value of Firm applies to Equity holders only when I believe the comparison should be value of equity with value of equity to arrive at impact on shareholders
Please helpIf debt lenders put more money in then yes – certainly the total debt increases, but that is not a gain. The gain is when market value goes up by more than the amount paid in, and that only happens for equity.
That is what I mean by saying that any increase in value due to taking over another company belongs only to the shareholders.This is probably where I’m confused – the debt lenders did put money in
because how else did their value go from (50% of $140) $70 to (50% of 189) $95 and market value includes that debt – value of firm belongs to D & E
As per the question “assuming the combined company’s capital structure stays the same as that of P’Co’s current capital structure” i.e. 50:50Yes – you are correct.
The debt lenders must have put money in. But how much is not really relevant because any gain (as I defined before) will go to the shareholders 🙂
Thank you, as always for your very prompt relies and sorry if I have strung it out a bit
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