Estimate the DCF value of the gains from the merger accruing to the shareholders

Question

Estimate the DCF value of the gains from the merger accruing to the shareholders of Chase and Chemical assuming that all the anticipated benefits and costs (in Ex 8) are realized. Assumptions: Discount rate = 15% (based on: 30 year T-bond rate = rf = 6.35%, equity beta = 1.2 and market risk premium = 7.4%). Incremental cash flows to shareholders (from case description and Ex 8): Restructuring cost of $ 1.9B realized at the end of 1995 (t = 0) b. Cost savings: $600M in 1996, $ 1050M in 1997 and $ 1, 700 in 1998 c. Revenues: decrease of $125M in 1996, $20.0M in 1997 and $120M in 1998 d. Assume that the steady-state growth perpetuity (TV) accrues in 1999. Both savings and revenues grow at a terminal growth rate g = 5% e. Tax rate = 34% TV_99 = CF_98 (1 + g)/k-g PV (TV_99): discount back 4 years at k = 15%. Gain from merger = PV(Cf_t) + PV(TV_99)

Explanation / Answer

TV99 = CF98(1+g) / (k-g) = 788.502 * 1.05/(0.15 - 0.5) = 8279.271

PV(TV99) = 8279.271 * 1 / (1.15)4 = 4744

Gain from merger = PV(CF after tax) + PV(TV99)

= -1900 + 313.5 + 591.13 + 788.502 + 4744 = - 206.868 + 4744 = 4537.132

The impact on the wealth of share holders because of merger will be positive because the meger value is positive and it will enhance the value of the shares. since the beta is used in ascertaining the value of merger is also 1.2 there is no need for recaluclation. there is enhancement of wealth by $4537.132 M

1995 1996 1997 1998 Restructuring cost (1900) 0 0 0 Cost saving 0 600 1050*1/1.15 = 913.04 1700*(1/1.15)(1/1.15) = 1285.44 Revenue increase 0 -125 20*1/1.15 = - 17.39 120*(1/1.15)(1/1.15) = - 90.74 Cashflow before tax (1900) 475 895.65 1194.7 Cashflow after tax (1900) 475*(1-.34) =313.5 895.65*(1-.34) =591.13 1194.7*(1-.34) =788.502 =CF98

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