ABC management is currently considering a merger with XYZ. Both companies are in the same industry, and both companies’ total shares sell at a ratio of price to free cash flow of 10 (market value=10*annual free cash flow). If the two companies merged, there is no reason to believe that this valuation multiple would change. ABC has 10 million shares outstanding, selling at a price of $17 per share. XZY has 7 million shares outstanding. Neither company has any debt. XYZ’s free cash flow per year is 5.75 mil. If ABC and XYZ were to merge, ABC believes that it could apply its superior inventory control and accounts receivable management techniques to XYZ and thereby boost XYZ’s annual free cash flow to 13.25 mil. The two companies’ management teams are now trying to negotiate the terms of a merger.

a) What is the value of XYZ to ABC?

b) ABC management proposes to pay $18 cash for each XYZ share. What is the Net Present Value (NPV) of this offer to ABC? What is the amount of premium paid?

Answer rating: 100% (QA)

a To determine the value of XYZ to ABC we need to calculate the value of XYZ based on its current free cash flow and the given valuation multiple The ... View the full answer