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%
Answer:
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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