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)

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