Exercise Essay

844 Words4 Pages
1. Synergy Valuation
a. Cost and revenue synergies
Managers of an acquiring company anticipate cost savings pretax of $50 million in the first year of the deal and $100 million the next and that thereafter the savings would grow @ inflation, 2%. Marginal tax rate is 30%. The firm must invest $1 billion to achieve these savings and starting in the third year must spend 5% of the pre-tax savings to sustain the rate of savings. As part of rationalization of operations, some assets will be sold generating a positive cash flow of $20 million net of tax in years 1 and 2 and $10 million in year 3. The analyst judges that these costs savings are rather certain, reflecting a degree of risk consistent with the variability in the firm’s
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The key assumption here is that the equity market does not anticipate this reduction. The following table provides further details:
| |Buyer (before) |Target (before) |
|WACC |10.2% |11.2% |
|Enterprise value ($ million) |6000 |6000 |
|Risk-free rate (%) |5% |5% |
|Equity market risk premium (%) |7% |7% |
|Levered beta |1.00 |1.30 |
|Debt ratio (%) |25 |45 |
|Tax rate (%) |40 |40 |
|Credit rating |AA |BBB |
|Current pre-tax yield on debt at prevailing rating (%)

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