FIN 703: MERGERS AND ACQUISITIONS
TUTORIAL 5
1. What does the word synergy in merger mean?
2. What is the fundamental aim of M&A transaction?
3. Why must one “think like an investor” when evaluating synergies? What could go wrong
when one does not think like an investor?
4. Explain in your own words the following equation, and provide definitions and examples :
V Synergies = V In place Synergies + V Real options Synergies
5. Suppose that managers anticipate cost savings pre-tax of $50 000 in the first year of the
deal, and $100 000 in the next year, and that thereafter the savings would grow at the rate
of 5%. The marginal tax rate is 22 %.
The firm must invest $80 000 in the initial period to achieve these savings, and must
spend 10% of the after-tax savings each year to sustain the rate of saving.
As part of the rationalisation of operations, some assets will be sold, generating a positive
cash flow of $20 000 net of tax in years 1, $10 000 in year 2, and $15 000 in year 3. The
analyst judges that these cost savings are rather certain.
Terminal value is expected to be $150 [Link] analyst decides to discount the cash flows
at the firm’s cost of debt of 5%
Required
Prepare the cash flow chart for the first five years.
Calculate the NPV
6. The managers conclude that the combination of two firms will expand revenues through
cross-selling of products, efficient exploitation of brands and geographic and product line
extension.
o They forecast revenue growth of $100 000 in the first year followed by a 15%
increase thereafter.
o The cost of goods underlying these new revenues is 35% of that year’s revenue.
o The marginal tax rate is 22 %.
o There will be an initial investment of $40 000 and 5 % of after tax cost savings
from year 1 onwards..
o As part of the rationalisation of operations, some assets will be sold, generating a
positive cash flow of $10 000 net of tax in year 1 and $5 000 in year 2.
o Terminal value is expected to be $200 000
o The discount rate to be used is 10%.
Required
Prepare the cash flow chart for the first five years.
Calculate the NPV
7. You are the CEO of a firm listed on SPSE. Your shareholders are widely dispersed, with
no shareholders having more controlling influence than the others. You have identified
three targets for Mergers and Acquisitions where each firm has DCF value of $200m and
has 100 m shares outstanding. The “base” from which any adjustments should be made is
the market share price of an individual share.
Target 1: Publicly held Target 2: Privately held Target 3: Publicly held company
company with a majority company with dispersed with a majority shareholder.
shareholder. shareholder. ◦ One shareholder owns
◦ One shareholder owns ◦ Here there is no control 51% of the shares in the
51% of the shares in the asymmetry arising from company.
company. the existence of a control ◦ All shares are illiquid.
◦ You wonder what share and of a group of You wonder what share
price to offer the majority minority shareholders. price to offer the majority
shareholder, and what ◦ But the shares to be shareholder, and what
price to offer the minority purchased are illiquid. price to offer the minority
shareholder. Privately, Privately, you believe a shareholder.
you believe a 30% control 30% discount from the ◦ Privately, you believe a
premium over the base base case for illiquidity is 30% control premium and
case valuation is justified. warranted. a 30 %z` illiquidity
discount are justified
relative to the base case
valuation.
Calculate:
Value of equity adjusted for possible illiquidity
% premium for control
Size of controlling block
Value of controlling block
Value of minority block
Value of equity adjusted for control asymmetry and illiquidity
Controlling block price per share
Minority block price per share.
Price to all if no control asymmetry
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