After failed merger discussions with a reluctant management, Bombay Co. plans to make a hostile bid for Catar Inc. The managements for both companies’ know that a potential acquisition would generate €1 million in synergies and cost savings annually. They also expect the appropriate cost of capital for these incremental cash flows to be 10%. For simplicity, assume that neither firm’s share price currently contains acquisition expectations. Further assume that if and when a bid for Catar's shares is made, all private information described above becomes public. Current public data about the two companies as stand-alone entities are presented below.
Bombay: Earnings (in millions) €10 Shares (in millions) 20 EPS €0.5 P/E ratio 10
Catar: Earnings (in millions) €1.5 Shares (in millions) 1.2 EPS €1.25 P/E ratio 8
Suppose Bombay announces its takeover intentions and offers four new Bombay shares for each Catar share. Assume that even though Catar's management is strongly opposed, the offer and takeover are generally believed to succeed without difficulty.
a) What is the present value of the expected gain (to Bombay and Catar combined) from the acquisition?
b) What is the announcement return (in percentage) on Bombay's share price?
c) What is the announcement return (in percentage) on Catar's share price?