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?
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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