Question- The following table summarizes the financial characterstics of 2 firms that are considering combining in a merge

& earn the same operating margin.

Both the firms will be in stable growth after 5 years growing at 4.25% a year in perpetuality & earning no excess return is t

Acquiring firm Target firm Combined firm Value without synergy

Beta 0.9 0.9 0.9
Pretax cost of debt,kd 5% 5% 5%
Debt to cost ratio, wd 30% 30% 30%
we 70%
Revenue 1000 5000 6000
Operating income 50 25 75
Pre tax Roc 15% 15% 15%
Reinvestment rate 70% 70% 70%
Length of growth period 5 5 5
Tax Rate 30% 30% 30%
Rf 4.25%
Risk Premium 4%

Stable growth rate 4.25% Synergy=

growth rate=ROC(i-t)*r
Growth Rate 7.350% after tax ROC is taken
FCFF= EBIT(1-T)(1-R)

Base FCFF 15.75 PV at WACC

FCff1 16.907625 15.8689990145
fcff2 18.1503354375 15.9888971252
fcff3 19.4843850921562 16.1097011253
fcff4 20.9164873964297 16.2314178591
fcff5 1215.80989453364 885.523936009
Firm Value without synergy 949.722951133
FCFF6 27.3875212399466
ke 7.85%
WACC 0.06545

R*ROC =g
r stable= g/ROC 0.64935064935065 Since roc is changing after 5 years, new rate will be t
Terminal Value 1193.35604531358
ring combining in a merger. Both firms have same COC, expect same growth in future

ning no excess return is there i.e ROC = WACC.

Combined firm Value with synergy

0.9
5%
30%

6000
90
15%
70%
5
30%

Combined firm Value with synergy-combined firm value without synergy

5 years, new rate will be taken to calculated FCFF6

Assume that after the merger, the combined firm will save 15 million pretax operating expenses (Cost Saving Synergy). Find

Acquiring firm Target firm Combined firm Value without synergy

Beta 0.9 0.9 0.9
Pretax cost of debt,kd 5% 5% 5%
Debt to cost ratio, wd 30% 30% 30%
we 70%
Revenue 1000 5000 6000
Operating income 50 25 75
Pre tax Roc 15% 15% 15%
Reinvestment rate 70% 70% 70%
Length of growth period 5 5 5
Tax Rate 30% 30% 30%
Rf 4.25%
Rprem 4%

Stable growth rate 4.25% Synergy=

growth rate=ROC(i-t)*r
Growth rate 7.350% after tax ROC is taken
FCFF EBIT(1-T)(1-R)

Base FCFF 18.9 PV at WACC

FCff1 20.28915 19.0427988174
fcff2 21.780402525 19.1866765503
fcff3 23.3812621105875 19.3316413503
fcff4 25.0997848757157 19.4777014309
fcff5 1458.97187344037 1062.62872321
Firm Value with synergy 1139.66754136
FCFF6 32.8650254879359
ke 7.85%
WACC 0.06545

R*ROC =g
r stable= g/ROC 0.64935064935065 Since roc is changing after 5 years, new rate will be take
Where ROC =WACC
Terminal Value 1432.02725437629

Synergy $189.94 million dollar

The Merger Should take place as the Firms Value with Synergy is positive and highe
without Synergy. Which means that the combined value of the two firms is higher t
firms combined before the merger.
i.e Vab>Value of A + Value of B
Also, the merger is resulting in saving 15 million in Pretax Operating Margin, leadin
Operating Income. This Merger can be called as Cost Saving Merger.
firms combined before the merger.
i.e Vab>Value of A + Value of B
Also, the merger is resulting in saving 15 million in Pretax Operating Margin, leadin
Operating Income. This Merger can be called as Cost Saving Merger.
s (Cost Saving Synergy). Find the Value of Synergy ?

Combined firm Value with synergy

0.9
5%
30%

6000
90
15%
70%
5
30%

Combined firm Value with synergy-combined firm value without synergy

5 years, new rate will be taken to calculated FCFF6

rgy is positive and higher than the Firms Value

he two firms is higher than the value of both

perating Margin, leading to increase in

Merger.
perating Margin, leading to increase in
Merger.

s
Ques- Assume that the synergy takes the form of strategic barriers to enter, that will keep competition out for a longer peri

Acquiring firm Target firm Combined firm Value without synergy

Beta 0.9 0.9 0.9
Pretax cost of debt,kd 5% 5% 5%
Debt to cost ratio, wd 30% 30% 30%
we 70%
Revenue 1000 5000 6000
Operating income 50 25 75
Pre tax Roc 15% 15% 15%
Reinvestment rate 70% 70% 70%
Length of growth period 5 5 10
Tax Rate 30% 30% 30%
Rf 4.25%
Risk Premium 4%

Stable growth rate 4.25% Synergy=

growth rate=ROC(i-t)*r
Growth Rate 7.350% after tax ROC is taken
FCFF= EBIT(1-T)(1-R)

Base FCFF 15.75 Present Value

FCff1 16.907625 15.8689990145009
fcff2 18.150335438 15.988897125221
fcff3 19.484385092 16.1097011252755
fcff4 20.916487396 16.2314178591048
fcff5 22.45384922 16.3540542228627
fcff6 24.104207138 16.4776171648065
fcff7 25.875866362 16.6021136856913
fcff8 27.77774254 16.7275508391661
fcff9 29.819406617 16.8539357321741
fcff10 1731.6091038 918.584521523927
1065.79880829273 <=== Firm Value With Synergy
ke 0.0785
WACC 0.06545

R*ROC =g
r stable= g/ROC 0.6493506494 Since roc is changing after 5 years, new rate will be taken to calculated FCFF6

FCFF11 39.005773429

Terminal Value 1699.5979707

Synergy=

Synergy =
As the Synergy have taken the form of strategic
keep competition out for a longer period. The gr
company has also incresed leading to more reve
And the Value of Firm before the merger is lowe
firm after the merger.
So the merger should take place.
petition out for a longer period i.e n=10 years

Combined firm Value with synergy

0.9
5%
30%

6000
75
15%
70%
10
30%

Combined firm Value with synergy-combined firm value without synergy

aken to calculated FCFF6

Combined firm Value with synergy-combined firm value without synergy

116.075857160093 million dollar

taken the form of strategic barriers to entry, which will
t for a longer period. The growth phase of the Merged
cresed leading to more revenue generation.
m before the merger is lower than the combined value of
r.
d take place.
 Consider that the two companies after the merger will have a increase in marginal after Tax ROC on new investment
firm. Assume all other Information remains unchanged. Find Synergy.

Acquiring firm Target firm Combined firm Value without s

Beta 0.9 0.9 0.9
Pretax cost of debt,kd 5% 5% 5%
Debt to cost ratio, wd 30% 30% 30%
we 70%
Revenue 1000 5000 6000
Operating income 50 25 75
New After Tax ROC 12.60% 12.60% 12.60%
Reinvestment rate 70% 70% 70%
Length of growth period 5 5 5
Tax Rate 30% 30% 30%
Rf 4.25%
Risk Premium 4%

Stable growth rate 4.25% Synergy=

growth rate=ROC*r
Growth Rate 0.0882 after tax ROC is taken
FCFF= EBIT(1-T)(1-R)

Base FCFF 15.75 PV at WACC

FCff1 17.13915 16.086301563
fcff2 18.65082303 16.429783998
fcff3 20.295825621 16.780600635
fcff4 22.085917441 17.138908077
fcff5 1301.3647458 947.83702374
1014.272618 <==Firm Value with synergy
FCFF6 29.314743017
ke 7.85%
WACC 0.06545

R*ROC =g
r stable= g/ROC 0.6493506494 Since roc is changing after 5 years, new rate will be taken to calculated FCFF6
Where ROC = WACC
Terminal Value 1277.3308504

Synergy=
Synergy=

Firms Value with Synergy is positive and higher than the Firms Va
Va.b> Value of A + Value of B
Also, the merger is resulting in increase of Return on Capital Emp
12.6%. This Merger is Revenue Generating, thus the Merger Sho
Firms Value with Synergy is positive and higher than the Firms Va
Va.b> Value of A + Value of B
Also, the merger is resulting in increase of Return on Capital Emp
12.6%. This Merger is Revenue Generating, thus the Merger Sho
ase in marginal after Tax ROC on new investments from 10.5% to 12.6% for the merged
y.

Combined firm Value with synergy

0.9
5%
30%

6000
90
12.60%
70%
5
30%

Combined firm Value with synergy-combined firm value without synergy

ew rate will be taken to calculated FCFF6

Combined firm Value with synergy-combined firm value without synergy

64.5496668786221 million dollar

h Synergy is positive and higher than the Firms Value without Synergy. i.e
A + Value of B
r is resulting in increase of Return on Capital Employeed from 10.5% to
ger is Revenue Generating, thus the Merger Should take place.
h Synergy is positive and higher than the Firms Value without Synergy. i.e
A + Value of B
r is resulting in increase of Return on Capital Employeed from 10.5% to
ger is Revenue Generating, thus the Merger Should take place.