American Health Care, a pharmaceutical firm, announces that it will be acquiring
ID: 2744788 • 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 the combined firm with synergy.
a.
5083.35
b.
4257.37
c.
3899.81
d.
3581.81
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
Option B.
Value of synergy firm= present value of free cash flows
After 2nd year the cash flows increases at rate of 5.5% through out life the formaule is
=cash flow at 2nd year*(1+growth)/(cost of capital-growth)
=(172/(1+10%)^1)+(203/(1+10%)^2)+((203*(1+5.5%)/(10%-5.5%))/(1+10%)^2)
=4257.37
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