CHAPTER 29
THE BIRDIE GOLF–HYBRID GOLF
MERGER
1. As with any other merger analysis, we need to examine the present value of the incremental cash
flows. The cash flow today from the acquisition is the acquisition cost plus the dividends paid
today, or:
Acquisition of Hybrid –$352,000,000
Dividends from Hybrid 96,000,000
Total –$256,000,000
Using the information provided, the cash flows to Birdie Golf from acquiring Hybrid Golf for the
next five years will be:
Year 1 Year 2 Year 3 Year 4 Year 5
Dividends from Hybrid $24,864,000 $8,192,000 $18,624,000 $26,496,000 $36,512,000
Tax-loss carryforwards 16,000,000 16,000,000
Terminal value of
equity 576,000,000
Terminal value of debt –192,000,000
Total $24,864,000 $24,192,000 $34,624,000 $26,496,000 $804,512,000
To discount the cash flows from the merger, we must discount each cash flow at the appropriate
discount rate. The additional cash flows from the tax-loss carry forwards and the proposed level
of debt should be discounted at the cost of debt because they are determined with very little
uncertainty.
The terminal value of the company is subject to normal business risk and must be discounted at a
normal rate. The current weight of debt and weight of equity in Hybrid’s capital structure is:
wD = .50 / (1 + .50)
wD = .33
wE = 1 – .33
wE = .67
The beta for Hybrid’s debt is:
D = (.08 – .06) / (.13 – .06)
D = .29
Thus, the overall beta for Hybrid is:
H = (.33 × .29) + (.67 × 1.30)
H = .96
Now, we can calculate the required return for normal operations of Hybrid, which is:
E(RH) = .06 + .96(.13 – .06)
E(RH) = .1273, or 12.73%
To find the discount rate for dividends, we need to find the new beta of equity for the merged
Hybrid. The new debt–equity ratio is 1, which implies a weight of debt and a weight of equity
equal to 50 percent. The new beta for equity must be:
New = [Old – (wD–new × wD–old] / wE–new
New = [.96 – (.50 × .33)] / .50
New = 1.59
So, the discount rate for the dividends to be paid in future is:
E(RDiv) = .06 + 1.59(.13 – .06)
E(RDiv) = .1713, or 17.13%
Now we can find the present value of the future cash flows. The present value of each year’s
cash flows, along with the appropriate discount rate for each cash flow, is:
Discoun
t
rate Year 1 Year 2 Year 3 Year 4 Year 5
17.13% $21,227,09
Dividends 2 $5,970,751 $11,588,613 $14,075,321 $16,558,962
Tax-loss 8% 13,717,421 12,701,316
TV of equity 12.73% 316,344,830
TV of debt 8% –130,671,974
$21,227,09
Total 2 $19,688,172 $24,289,929 $14,075,321 $202,231,818
And the NPV of the acquisition is:
NPV = –$256,000,000 + 21,227,092 + 19,688,172 + 24,289,929 + 14,075,321 + 202,231,818
NPV = $25,512,330.96
2. Since the acquisition is a positive NPV project, the most Birdie would offer is to increase the
current cash offer by the current NPV, or:
Highest offer = $352,000,000 + 25,512,330.96
Highest offer = $377,512,330.96
The highest share price is the total high offer price, divided by the shares outstanding, or:
Highest share price = $337,512,330.96 / 5,200,000 shares
Highest share price = $72.60
3. To determine the current exchange ratio which would make a cash offer and a share offer
equivalent, we need to determine the new share price under the original cash offer. The new
share price of Birdie after the merger will be:
PNew = [$94 × 11,600,000 + $25,512,330.96] / 11,600,000
PNew = $96.20
So, the exchange ratio which would make the cash offer and share offer equivalent is:
Exchange ratio = $68.75 / $96.20
Exchange ratio = .7147
4. The highest exchange ratio Birdie would accept is an exchange ratio that results in a zero NPV
acquisition. This implies the share price of Birdie remains unchanged after the merger, so the
exchange ratio is:
Exchange ratio = $68.75 / $94
Exchange ratio = .7314
