Problem:
Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $500,000 per year in perpetuity. Velcro Saddles considers offering Pogo shareholders a 50% holding in Velcro Saddles. The opportunity cost of capital is 8%.
Required:
Question 1: What is the value of the stock in the merged company held by the original Pogo shareholder s?
Question 2: What is the cost of the stock alternative?
Question 3: What is the merger's NPV under the stock offer?
Note: Be sure to show how you arrived at your answer.