Download Bonus Assignment solution

BUS 330
Fall 2016
Extra Credit Answers (approximate)
1. The simplified balance sheet for the 2 companies are:
TWX
ATT
Assets $63.8 B
$402.7 B
Debts $40.2 B
$280.0 B
Equity $23.6 B
$122.7
Beta 1.08
0.34
ATT has 6.14 Billion shares outstanding at the moment, and the TWX shareholders will own 15% of the
company post-merger. This suggests that post-merger, there will be 7.22 billion shares (the extra 1.08
billion shares represent 15% of 7.22 billion). If ATT shares remain at their current price ($38.55 on the
day I checked) then ATT will raise $41.6 billion from issuing the new shares.
If the total cost of the acquisition is $85.4 billion, then $43.8 billion of new debt will be added to the
combined balance sheet after the acquisition.
Finally, the current book value of TWX shares is $23.6 billion, but ATT will be spending $85.4 billion to
obtain them. Therefore the transaction will wipe out the $23.6 billion of TWX equity, but add $85.4
billion in new debt and new shares to the combined company’s balance sheet. This can be offset by
adding $61.8 billion on the asset side as “Goodwill”.
The post-merger balance sheet will look something like:
AT&TW
Assets:
TWX Assets $63.8
ATT Assets $402.7
Goodwill $61.8
Total: $528.3
Liabilities:
TWX Debts $40.2
ATT Debts$ 280.0
New Deb t $43.8
Total Debt: $364.0
Equity:
ATT equity: $122.7
New shares: $41.6
Total Equity: $164.3
2. The beta assigned to the new company depends on (a.) the systematic risk inherent in the
company’s assets, and (b.) on the degree of leverage on the company’s balance sheet.
To estimate the degree of risk inherent in the company’s assets, we can work backwards from the
known beta’s of the 2 present companies’ shares. TWX shares have a beta of 1.08. The TWX balance
sheet has $63.8 billion of assets and $23.6 of equity, but the shares were trading for about $80 per share
before the merger announcement, so the market value of the shares was $61.7 billion, which suggests
that the market value of the company’s assets is $38.1 billion more than book value. If you add $38.1
“goodwill” to the TWX balance sheet, then the book value of equity is equal to market value.
Adjusted TWX balance sheet:
TWX Assets (book value) $63.8
TWX goodwill
$38.1
Total:
$101.9
Liabilities:
TWX Debt:
TWX Equity:
$40.2
$61.7
Total:
$101.9
In the balance sheet above, each dollar of equity “captures” the risk flowing from $1.65 of the
company’s assets (1.65 = 101.9/61.7). If the resulting beta for the shares is 1.08, then the assets’ return
should have a beta of 1.08/1.65 = 0.65
We can follow the same process for ATT:
ATT has 6.14 billion shares that were trading for about $40 per share before the announcement. That
generates a market value of $245.6 billion. Book value of equity is 122.7, so we add 122.9 of goodwill to
ATT’s balance sheet to get approximate market valuation.
Adjusted ATT balance sheet:
ATT Assets (book value) $402.7
ATT goodwill
$122.9
Total:
$525.6
Liabilities:
ATT Debt:
ATT Equity:
$280.0
$245.6
Total:
$525.6
ATT shares have a beta of 0.34. Each share represents $2.14 of assets, so each dollar of assets generates
a risk of 0.34/2.14 = 0.16
When ATT makes the purchase of TWX, the combined company’s balance sheet (again adjusted to make
the equity equal to market value:
Adjusted ATTWX balance sheet:
TWX Assets (book value) $63.8
TWX goodwill
$38.1
ATT Assets (book value) $402.7
ATT goodwill
$122.9
Acquisition goodwill
$25.9
Total:
$653.4
Liabilities:
TWX Debt:
ATT Debt:
Acquisition Debt
$40.2
$280
$43.8
Equity:
Newly-issued equity:
Total Equity:
$245.6
$43.8
$289.4
Total:
$653.4
Why did we do all this? (Good question…) With the balance sheet above, we can use what we know
about the risk originating from the company’s assets -- and the degree of leverage of the combined
company – to estimate the beta of the company that emerges from the merger.
The beta of the new company’s total assets will be the weighted average of the betas of the different
asset types. The TWX assets (16% of total assets) have a beta of 0.65, the ATT assets (80% of total
assets) have a beta of 0.16. What’s left are the 4% of assets from the acquisition goodwill – the
supposed “synergies” arising from the merger that justifies the premium paid over the market value of
TWX shares. Since this is only 4% of the weighted average, it’s not going to matter too much what value
we assign to it, but let’s assume this has the same beta value as TWX assets (0.65).
Therefore the weighted average beta of the assets of the new company is:
Beta = .16 * 0.65 + .80 * 0.16 + .04 * 0.65 = 0.26
Each dollar of equity of the new company will absorb the risk from 653.4/289.4 = $2.26 of assets, so the
resulting beta of the shares should be 2.26 * 0.26 = 0.59
3. If the combined company is able to absorb all the revenues from TWX and eliminate half of the
selling, general, and administrative expense currently incurred by TWX (this is a very, very, big
“if”) – then this would be a $2.4 billion cost savings per year, or an additional $2.4 billion of pretax income. Income tax is currently about 30% of its income, so that would leave $1.7 billion of
additional net income. This amount would increase TWX earnings per share by 44%. Therefore
cost savings of this amount would be enough to justify the 35% premium over current market
price that is paid by ATT.
4. This questions asks us to consider what happens if the “acquisition goodwill” in the combined
balance sheet above is in fact zero instead of $25.9 billion. Therefore there will be a decline in
share value of this amount. If the new company’s 7.22 billion shares absorb a loss of $25.9
billion, this works out to a $3.58 per share loss. (Note: the market price of ATT shares fell by
about $3 per share when the merger was announced.)