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Two identical firms have yearly after-tax cash flows of $20 million each, which are expected to...

Two identical firms have yearly after-tax cash flows of $20 million each, which are expected to continue into perpetuity. If the firms merged, the after-tax cash flow of the combined firm would be $42 million. Assume a cost of capital of 12%. Does the merger generate synergy? What is change in overall firm value from the merger? What is the value of the target firm to the bidding firm?

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Answer #1
Company-I Company-II Merged firm
Cash flow 20 20 42
Discount rate 12% 12% 12%
PV of future cash flows =20/12% =20/12% =42/12%
PV of future cash flows 166.6667 166.6667 350
Value of merged firm     350.00
Less-Company I Value    (166.67)
Less-Company II Value    (166.67)
Synergy Gain        16.67
Overall firm value will increase by 16.67
Maximum value of target firm to the bidding firm
Firm's own value     166.67
Add Synergy gain        16.67
Total value     183.33
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