American Health Care, a pharmaceutical firm, announces that it will be acquiring
ID: 2744790 • Letter: A
Question
American Health Care, a pharmaceutical firm, announces that it will be acquiring Healthcare Associates, a hospital management firm. The following table summarizes the expected cash flows to the firm at each of these firms, run independently, and the expected cash flows from the combined firm with synergy benefits. The cost of capital for both firms, run independently, is 10%; the combined firm will have the same cost of capital. The expected growth rate in the cash flows after year 2 is 5%, for the firms run independently. And the combined firm is expected to be able to grow faster at 5.5% after year 2.
Expected Cash Flows
Company
FCF1
FCF2
Growth Rate after Year 2
AHP
100
120
5%
HA
60
69
5%
Combined (with Synergy)
172
203
5.5%
Estimate the value of synergy.
a.
675.56
b.
616.18
c.
1501.54
d.
812.70
Expected Cash Flows
Company
FCF1
FCF2
Growth Rate after Year 2
AHP
100
120
5%
HA
60
69
5%
Combined (with Synergy)
172
203
5.5%
Explanation / Answer
Present Value of AHP:
Year
FCF
PVF (10%)
PV of FCF
1
100
0.909
90.9
2
120
0.826
99.12
2
2520 (120 * 105% / (0.1-0.05))
0.826
2081.52
2271.54
Present Value of HA:
Year
FCF
PVF (10%)
PV of FCF
1
60
0.909
54.54
2
69
0.826
56.994
2
1449 (69 * 105% / (0.1-0.05))
0.826
1196.874
1308.408
Present value of Combined:
Year
FCF
PVF (10%)
PV of FCF
1
172
0.909
156.348
2
203
0.826
167.678
2
4759.22 (203 * 105.5% / (0.1-0.055))
0.826
3931.1175
4255.1435
Value of AHP + HA = $2271.54 + $1308.408 = $3579.948
Combined Value = $4255.1435
Value of Synergy = $4255.1435 - $3579.948
= $675.1955 (approx)
Correct Option is a) 675.56
Year
FCF
PVF (10%)
PV of FCF
1
100
0.909
90.9
2
120
0.826
99.12
2
2520 (120 * 105% / (0.1-0.05))
0.826
2081.52
2271.54
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