You have been asked to value the synergy in a merger by your boss, who also happens to be an avid believer in Economic Value Added (EVA). As a result, you are given the following information on the two firms:
G & P is a diversified consumer product company with $ 2 billion in capital invested, a return on capital of 13%, and a cost of capital of 11%. The firm is assumed to be in stable growth, and the EVA is expected to grow 5% a year in perpetuity.
BandAdd is a smaller company that produces only perfumes. It has $ 500 million in capital invested, earning a return on capital of 16% with a cost of capital of 12%. This firm is also in stable growth, and the EVA is expected to grow 5% a year in perpetuity.
Both firms have 40% tax rates.
Using the above information, answer the following questions:
Value G & P using the EVA approach. ( 20 points)
Value BandAdd using the EVA approach. ( 20 points)
As a result of the merger, you expect the firm to be able to lower its cost of capital to 10% (as a result of increased debt capacity) and to post an increase in the combined operating income of 10% (as a result of economies of scale). Estimate the value of synergy in this merger. (60 points)
Note: $1,000 equals $1 billion on your spreadsheet.
