Reference no: EM132906705

Expansion Inc. approaches Genie Inc. about an acquisition. Gennie Inc has the same beta (1.2) and required return of 10% as Expansion Inc. Genie has the following attributes:

• Genie has perpetual cash earnings of $100 million that it pays out as a dividend each year.
• Genie has a value of $1000 million and has 100 million shares outstanding with a $10 share price.

The thought is that by combining the businesses they can get extra sales and profits in future years, though in the in the short run this might damage profits. The extra profit/cash flow profile is

• Extra cash/profit in year 1 = -$1 million (negative $1 million)
• Extra cash/profit each year starting in year 2 and every year after = $21 million
• Note we are at the start of year 1, so first cash flow is in one year.
• Expansion Inc. offers 11 million total shares of Expansion Inc. stock to Genie's investors - that is 0.11 shares of Expansion Inc. per share of Genie. Expansion Inc. shareholders keep their shares.

Problem a) Assuming the deal is done at the start of year 1, what is the price of a share of new Expansion Inc. stock after the deal is done?

Note the synergy value today = Cash Flow year 1 / 1.1 + (Cash flow year 2 / .10) / 1.1
The second piece of synergy value is the continuing value at the end of year one discounted back to the start of year 1.

Problem b) What happens to the new Expansion Inc.'s EPS for year 1 compared to what EPS would be without the merger?

Problem c) If Expansion Inc. management must have synergy and their EPS has to go up in year ahead (year 1) to justify doing the merger, would they walk away from this deal - and would that be a mistake? Explain why or why not briefly.