Question

A survey of a local market has provided the following average cost data. Wells Fargo bank (WFB) has assets of $2 million and an average cost of 25%. Life Insurance Company Alliance (LICA) has assets of $6 million and an average cost of 35 percent. Pension Fund C (CPFC) has assets of $3 million and an average cost of 30 percent. For each firm, average costs are measured as a proportion of assets. WFB is planning to acquire LICA and CPFC with the expectation of reducing overall average costs by eliminating the duplication of services.

a. What should be the average cost after acquisition for WFB to justify this merger?

b. If WFB plans to reduce operating costs by $600,000 after the merger, what will be the average cost of the new firm?

Answer 1

a. What should be the average cost after acquisition for WFB to justify this merger?

• To Justify the Merger the Average cost should be less than 35 %

so,After Merger cost equal wacc of proportion Assets : WFB+LICA+CPFC

=2 MN*0.25 +6 MN *0.35+ 3 MN * 0.3

=0.5+2.1+.9

=3.5 MN

Total Assets = 2+6+3

=11

Cost = 3.5/11

=31.8%

b. If WFB plans to reduce operating costs by $600,000 after the merger, what will be the average cost of the new firm

Cost reduce 600000 = 3.5 mn - 0.6

=2.9 Mn

Averge cost of new firm in = 2.9 /11

=26.36 %