Consider the following information available on two companies: Trillium BECO 60p Earnings per share (recent) Dividends per share (recent) Number of shares 16p 8p 30p 8m 2m Share price 800p 104p The cost of equity capital for both firms is 10%. BECO is expected to produce a growth in dividends of 3.5% per annum to infinity with its current strategy and management. However, if Trillium acquired BECO and applied superior management and gained benefits from economies of scale the growth rate would rise to 7% on the same capital base. The transaction costs of the merger would amount to £600,000. Required: Find out the value that would be created from the merger.

Dividend per Share of BECO = 8p or  0.08

Cost of Equity of BECO = 10%

Current Growth Rate = 3.5%

After Merger Growth Rate = 7%

Number of Shares of BECO = 2 Million

Transaction Cost of Merger =  600,000

As per Gordan Growth Model,

Value of Share = Dividend per Share * (1 + Growth Rate) / (Cost of Equity - Growth Rate)

Value of Share (pre merger) = 0.08 * (1 + 3.5%) / (10% - 3.5%)

Value of Share (pre merger) =  1.27

Thus, value of share pre merger of the BECO should be  1.27.

As per Gordan Growth Model,

Value of Share = Dividend per Share * (1 + Growth Rate) / (Cost of Equity - Growth Rate)

Value of Share (post merger) = 0.08 * (1 + 7%) / (10% - 7%)

Value of Share (post merger) =  2.85

Thus, value of share post merger of the BECO should be  2.85.

Value created by Merger = (Value per Share post merger - Value per Share pre merger) * No. of Shares O/S of BECO - Transaction Costs

Value created by Merger = (2.85 - 1.27) * 2,000,000 - 600,000

Value created by Merger = 3,158,974.36 - 600,000

Value created by Merger =  2,558,974.36

Thus, Value created by merger is  2,558,974.36.