In this scenario, let’s suppose that Company X is preparing a deal to acquire Company Y. Sam estimated that the merger would produce $85 million of annual cost savings, from operations, general and...

In this scenario, let’s suppose that Company X is preparing a deal to acquire Company Y. Sam estimated that the merger would produce $85 million 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 2.5% a year. Also, Sam is assuming an after-tax integration cost of $0.1 billion, and taxes of 20%. Assume that the integration cost of $0.1 billion happens one year after the merger is completed (year 1). Sam is using a cost of capital of 10% to value the synergies.

Company Y’s equity is trading at $2.3 billion (market value of equity). Company X is planning to pay a 32% premium for company Y.

1)








Question 1) Compute the value of the synergy as estimated by Sam. Show your calculations.

Synergy =


______________million dollars

2)








Question 2) Does the estimate of synergies in question 1 justify the premium that Company X offered to Company Y? (275 word limit for response to Question 2.)