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Question - Company A is preparing a deal to acquire company B. One analyst estimated that the merger would produce 175 million dollars of annual cost savings, from operations, general and administrative expenses and marketing. These annual cost savings are expected to begin three years from now, and grow at 3% a year. In addition the analyst is assuming an after-tax integration cost of 0.25 billion, and taxes of 21%. Assume that the integration cost of 0.25 billion happens right when the merger is completed (year 0). The analyst is using a cost of capital of 9% to value the synergies.
Company B's equity is trading at 4.3 B dollars (market value of equity). Company A is planning to pay a 32% premium for company B.
a) Compute the value of the synergy as estimated by the analyst. Please show your calculations.
b) Does the estimate of synergies in a) justify the premium that company A offered to company B? Explain your answer.
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