Hugo Comp. is analyzing the possible purchase of Vargas Inc. No one of the companies has any type debt. Hugo Comp. forecasts that the purchase would increase its annual after tax cash flow by $450,000 indefinitely. The current market value of Vargas Inc. is $8 million, while Hugo Comp. has a current market value of $24 million. The appropriate discount rate for the incremental cash flows is 9 percent. Hugo Comp. is trying to decide whether it would offer 30 percent of its stock or $10 million in cash to Vargas.
a. What is the synergy from the merger?
b. What is the value of Vargas Inc. to Hugo Comp.?
c. What is the cost to Hugo Comp. of each alternative?
d. What is the NPV to Hugo Comp. of each alternative?
e. What alternative should Hugo Comp. use?