# Managers conclude that the com

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.

They forecast new revenues of \$100 million in the first year and \$200 million in year two, growing at 2.5% per year there after. The cost of goods underline these new revenues is 45% of the revenues.

To achieve these synergies will require an investment of \$400 million initially, and 5% of the added revenue each year, to find working capital growth.

Find the net present value of the synergy is using a discount rate of 15% and a marginal tax rate of 40%

NPV = PV of Cash Inflows – PV of Cash Outflows

Cash Inflows per anum :

Year1 :

Sales = \$ 100 M

COGS @ 45% = \$ 45M

Net Inc in Rev = \$ 55M [ Sales – COGS ]

Tax @ 40% = \$ 22M

PAT = \$ 33M

Year2 :

Sales = \$ 200 M

COGS @ 45% = \$ 90M

Net Inc in Rev = \$ 110M [ Sales – COGS ]

Tax @ 40% = \$ 44M

PAT = \$ 66M

Year3:

PAT of Year 3 = PAT of Year2 (1+g)

= \$ 66M ( 1+0.025)

= \$ 66M ( 1.025)

= \$ 67.65M

PV of Cashflows from 3rd year onwards:

P2 = PAT3 / (Ke – g)

= \$ 67.65 M / ( 15% – 2.5%)

= \$ 67.65 M / 12.5%

= \$ 541.20 M

PV of Cash Inflows:

PV of Cash Outflows:

WC Increament:

Year1 = \$ 100M * 5%

= \$5M

Year2 = \$200M – \$ 100 M ( Added Rev )

= \$ 100M * 5%

= \$ 5M

Year3 = [ [ \$ 200 * 1.025 ] – 200 ] * 5%

= [205 – 200 ]* 5%

= 5 * 5%

= 0.25M

Year 4 = [ [ 205 * 1.025 ] – 205 ] * 5%

= [210.125 – 205 ]* 5%

= 5.125 * 5%

= 0.25625

PV of WC cash Flows = CF4 / (Ke – g )

= 0.25625 / (15% – 2.5 %)

= 0.25625 / 12.5%

= \$ 2.05M

NPV = Pv of Cash Inflow – PV of Cash Outflows

= \$ 487.80 M – \$ 409.64 M

= \$ 78.16M

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