Exercise Essay

850 Words Nov 24th, 2014 4 Pages
Exercises
1. Synergy Valuation
a. Cost and revenue synergies
Managers of an acquiring company anticipate cost savings pretax of $50 million in the first year of the deal and $100 million the next and that thereafter the savings would grow @ inflation, 2%. Marginal tax rate is 30%. The firm must invest $1 billion to achieve these savings and starting in the third year must spend 5% of the pre-tax savings to sustain the rate of savings. As part of rationalization of operations, some assets will be sold generating a positive cash flow of $20 million net of tax in years 1 and 2 and $10 million in year 3. The analyst judges that these costs savings are rather certain, reflecting a degree of risk consistent with the variability in the firm’s
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The market value weight of the buyer in the new company will be 50%. It is assumed that new company will be an enterprise value of $12 billion.

2. Earnout Example
Consider the acquisition of Power Track, a privately owned manufacturer of aerobic and body building machines. At closing on 31 December 2003, Conrad Owens, its owner, would receive the following considerations from R-II Inc.: (a) A cash payment of $3 million due at closing. (b) An 8% annual coupon 4-year subordinated note issued by R-II, for $5 million with principal payable in four equal annual instalments. (c) A contingent payment to take effect at the end of the 4th year equal to one times EBITDA.

R-II would assume Power Track’s net debt of $ 6.2 million. Under the terms proposed by R-II, Power Track would become a wholly owned subsidiary of R-II, and Mr. Owens would stay as its manager with a 4-year contract and competitive compensation. At the end of the 4th year, Owens would receive the contingent payment and retire. In addition the following information is available:

• R-II’s outstanding subordinated notes are priced to yield 9%. • R-II’s corporate tax rate is 40%. • Mr. Owens is confident that under his management and with the support of R-II, Power Track’s EBITDA would grow at 20% per annum during the following four years from its current level of $4 million. • R-II has determined that Power Track’s free cash flow should be discounted at a WACC of 12%.

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