The maximum premium payable is equal to the maximum additional benefit created from the acquisition of Tori Co, with no increase in value for the shareholders of Vogel Co (although the shareholders of Vogel Co would probably not approve of the acquisition if they do not gain from it).
The additional benefit can be estimated as the sum of the cash gained (or lost) from selling the assets of Department C, spinning off Department B and integrating Department A, less the sum of the values of Vogel Co and Tori Co as separate companies.
Estimation
Cash gained from selling the assets of Department C
= (20% x $98·2m) + (20% x $46·5m x 0·9) – ($20·2 + $3m)
= $19·64m + $8·37m – $23·2m = $4·81m
Value created from spinning off Department B into Ndege Co
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Value of Ndege Co =
Present value of cash flow in year 1: $7·62m x 1·2 x 1·1–1 = $8·31m
Add : present value of cash flows from year 2 onwards:
($9·14m x 1·052)/(0·1 – 0·052) x 1·1–1 = $182·11m
Less debt = $40m
Value to shareholders of Ndege Co = $150·42m
Vogel Co's current value = $3 x 380m = $1,140m
Vogel Co, profit after tax = $158·2m x 0·8 = $126·56m
Vogel Co, PE ratio before acquisition = $1,140·0m/$126·56m = 9·01 say 9
Vogel Co, PE ratio after acquisition = 9 x 1·15 = 10·35
Tori Co, PE ratio before acquisition = 9 x 1·25 = 11·25
Tori Co's current value = 11·25 x ($23·0 x 0·8) = $207·0m
Value created from combined company
($126·56m + 0·5 x $23·0m x 0·8 + $7m) x 10·35 = $1,477·57
Based on the calculations given above, it is estimated that the value created will be 64·9% or $285·80m.
However, Vogel Co needs to assess whether the numbers it has used in the calculations and the assumptions it has made are reasonable. For example, Ndege Co's future cash flows seem to be growing without any additional investment in assets and Vogel Co needs to establish whether or not this is reasonable. It also needs to establish how the increase in its PE ratio was determined after acquisition. Perhaps sensitivity analysis would be useful to show the impact on value changes, if these figures are changed. Given its poor record in generating value previously, Vogel Co needs to pay particular attention to these figures.
