# How are synergies calculated in the merger model?

FinanceFinance ManagementBanking & Finance

Consider the following table −

Company 1Company 2
Revenue ($)1000000500000 Cost of goods sold ($)750000270000
EBIR ($)250000125000 Growth Rate (Expected)5%9% Cost of capital11%14% Assume the following − • Cost of goods sold is reduced from 75% to 60% of revenues. • Tax rate = 32%. • Weighted average cost of capital = 14%. • Weighted average growth rate = 6%. ## Solution The solution is as follows − ### Before merger • Company 1 Cash flows = (1000000 – 750000) * 0.68 >=$170000
Value of firm = $170000 * 1.05/ (0.11-0.05) = 178500/0.06 =>$ 2975000

• Company 2
Cash flows = (500000 – 270000) * 0.6 => $156400 Value of firm =$ 156400 * 1.09/ (0.14-0.09)
= 170476/0.05 => $3409520 • Combined (company 1 + company 2) Combined value =$ 297500 + $3409520 =$ 3707020

### After merger

• Revenue = $1000000 +$500000 => $1500000 After merger cost of goods sold revenue reduced to 60% =>$1500000 * 0.60 => $900000 • EBIT =>$1500000 − $900000 =>$600000

• Post tax => $600000 * 0.68 =>$408000

• Value of firm = 408000 * 1.06/ (0.14-0.06) => 432480/0.08 => 5406000

• Value after post-merger = $5406000 -$3707020 = \$1698980 (increased)

Published on 19-Jul-2021 09:45:36
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