Reference no: EM132576401

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 two years from now, and grow at 2% a year. In addition the analyst is assuming an after-tax integration cost of 0.3 billion, and taxes of 20%. Assume that the integration cost of 0.3 billion happens right when the merger is completed (year 0). The analyst is using a cost of capital of 8% to value the synergies.

Company B's equity is trading at 2.3 B dollars (market value of equity). Given this, Company A is planning to pay a 30% premium for company B.

a) Compute the value of the synergy as estimated by the analyst. Please show your calculations. (Synergy = million dollars)

b) Does the estimate of synergies in a) justify the premium that company A offered to company B? Explain your answer