Reference no: EM132582037

The Elgin Golf-Dutton Golf Merger

Elgin Golf Inc. has been in merger talks with Dutton Golf Company for the past six months. After several rounds of negotiations, the o!er under discussion is a cash o!er of $250 million for Dutton 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.

Bruce Wayne, the financial o"cer for Elgin, has been instrumental in the merger negotiations. Bruce has prepared the following pro forma financial statements for Dutton Golf, assuming the merger takes place. The financial statements include all synergistic benefits from the merger.

If Elgin Golf buys Dutton Golf, an immediate dividend of $67.5 million would be paid from Dutton Golf to Elgin. Stock in Elgin Golf currently sells for $87 per share, and the company has 18 million shares of stock outstanding. Dutton Golf has 8 million shares of stock outstanding. Both companies can borrow at an 8% interest rate. Bruce believes the current cost of capital for Elgin Golf is 11%. The cost of capital for Dutton Golf is 12.4%, and the cost of equity is 16.9%. In five years, the value of Dutton Golf is expected to be $270 million.

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

Question 1. Suppose Dutton shareholders will agree to a merger price of $31.25 per share. Should Elgin proceed with the merger?

Question 2. What is the highest price per share that Elgin should be willing to pay for Dutton?

Question 3. Suppose Elgin is unwilling to pay cash for the merger but will consider a stock exchange. What exchange rate would make the merger terms equivalent to the original merger price of $31.25 per share?

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

                                    2018                         2019                            2020               2021                  2022

Sales                  $360,000,000      $ 405,000,000         $ 450,000,000     $ 508,500,000    $562,500,000

Production costs  248,000,000           284,000,000           315,000,000        355,500,000      393,000,000

Depreciation         36,000,000            41,000,000           45,000,000             51,000,000       56,000,000

Other expenses     33,000,000            36,000,000              37,000,000            38,000,000       38,000,000

EBIT                    $ 43,000,000          $ 44,000,000          $ 53,000,000         $ 64,000,000    $ 75,500,000

Interest               8,500,000                10,000,000                 11,000,000         11,250,000       12,500,000

Taxable income        $ 34,500,000          $ 34,000,000              $ 42,000,000       $ 52,750,000     $ 63,000,000

Taxes (40%)              13,800,000             13,600,000              16,800,000            21,100,000     25,200,000

Net income               $ 20,700,000            $ 20,400,000              $ 25,200,000         $ 31,650,000  $ 37,800,000

Additions to retained earnings

                                0                         $ 15,400,000                 $ 11,700,000       $ 11,700,000     $ 10,800,000