Birdie Golf, Inc., has been in merger talks with Hybrid Golf Company for the past six months. After several rounds of negotiations, the offer under discussion is a cash offer of $155 million for Hybrid Golf. Both companies have niche markets in the golf club industry, and both believe that a merger will result in synergies due to economies of scale in manufacturing and marketing, as well as significant savings in general and administrative expenses.

Bryce Bichon, the financial officer for Birdie, has been instrumental in the merger negotiations. Bryce has prepared the following pro forma financial statements for Hybrid Golf assuming the merger takes place. The financial statements include all synergistic benefits from the merger.

If Birdie Golf buys Hybrid Golf, an immediate dividend of $45 million would be paid from Hybrid Golf to Birdie. Stock in Birdie Golf currently sells for $71 per share, and the company has 14 million shares of stock outstanding. Hybrid Golf has 6.4 million shares of stock outstanding. Both companies can borrow at an 8 percent interest rate. Bryce believes the current cost of capital for Birdie Golf is 11 percent. The cost of capital for Hybrid Golf is 12.4 percent, and the cost of equity is 16.9 percent. In five years, the value of Hybrid Golf is expected to be $190 million.

Bryce has asked you to analyze the financial aspects of the potential merger. Specifically, he has asked you to answer the following questions.

QUESTIONS

1. Suppose Hybrid shareholders will agree to a merger price of $24.22 per share. Should Birdie proceed with the merger?

2. What is the highest price per share that Birdie should be willing to pay for Hybrid?

3. Suppose Birdie is unwilling to pay cash for the merger but will consider a stock exchange. What exchange ratio would make the merger terms equivalent to the original merger price of $24.22 per share?

4. What is the highest exchange ratio Birdie should be willing to pay and still undertake the merger?

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2022 2023 2024 2025 2026 Sales $264,000,000 $300,000,000 $332,000,000 $356,000,000 $396,000,000 Production costs 185,000,000 210,000,000 232,400,000 249,200,000 277,200,000 Other expenses 26,400,000 30,400,000 32,800,000 36,000,000 39,200,000 Depreciation 28,700,000 28,800,000 21,600,000 $ 31,000,000 24,800,000 26,400,000 EBIT $ 34,800,000 $ 40,400,000 $ 42,100,000 $ 50,800,000 Interest 6,000,000 7,200,000 8,400,000 8,000,000 $ 32,400,000 8,800,000 Taxable income $ 25,000,000 $ 27,600,000 $ 33,700,000 $ 42,000,000 Taxes (21%) 5,250,000 $ 19,750,000 7,077,000 $ 26,623,000 5,796,000 6,804,000 $ 25,596,000 8,820,000 Net income $ 21,804,000 $ 33,180,000 Additions to retained earnings $ 12,800,000 $ 15,000,000 $ 17,000,000 $ 20,000,000