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Valuing Synergies

Copyright (C) 2003 by Robert F. Bruner.

This spreadsheet supports the analysis of synergies in acquisitions. Please


see the Chapter 11, "Valuing Synergies" in Applied Mergers and Acquisitions
by Robert Bruner for a discussion of these models and their derivation.
To use the model, insert assumptions in blue-shaded cells. All other values
are calculated.
This software was prepared by Professor Robert F. Bruner,
http:/faculty.darden.edu/brunerb/.
This software was prepared solely for non-commercial educational purposes as a supplement to the book, Applied Mergers and
Acquisitions, by Robert F. Bruner. While it has been reviewed with care, and to the best of the author's knowledge performs as
described in the book, the publisher and author do not represent that this software is error-free, and cannot be accountable for
errors or omissions, nor for any liability arising from uses of this software.
ALL WARRANTIES, EXPRESS AND IMPLIED, INCLUDING THE WARRANTY OF MERCHANTABILITY, AND FITNESS FOR A
PARTICULAR PURPOSE, ARE HEREBY DISCLAIMED. NEITHER THE AUTHOR OR PUBLISHER SHALL BE LIABLE OR
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Copyright 2003 by Robert F. Bruner. All rights reserved. Use is subject to the terms and conditions given on the "Intro" page.

Cost Synergies

Year
1
2
3
4
5
6
7
8
9
10
11
12
13

Pre-Tax Cost Savings, Constant Dollars


Expected Inflation Rate
Growth Rate of FCF (nominal), in perpetuity
Discount Rate
Ongoing Investment/Savings (year 3+)
Pre-Tax Cost Savings, Current Dollars
Tax Expense (@ .40)
After-Tax Cost Savings
Less: Investment Necessary to Realize the Savings
Plus: Disinvestment Associated with the Savings
Subtotal
Terminal Value
Free Cash Flow

14 Net Present Value of Cost Savings


15 Internal Rate of Return of Synergy Investment

$ 50 $ 100 $100 $ 100 $


2%
2%
2%
2%

100
2%

2%
6%
5%
$ 51 $ 104 $106 $ 108 $
(20)
(42)
(42)
(43)
31
62
64
65
$ (1,000)
(5)
(5)
20
20
10
(1,000)
51
82
68
60
$ (1,000) $ 51
$428
15%

$ 82

$ 68 $ 60

110
(44)
66
(6)
61
1,548
$ 1,609

Copyright 2003 by Robert F. Bruner. All rights reserved. Use is subject to the terms and conditions given on the "Intro" page.

Revenue Enhancements
The analysis of revenue enhancements is similar to cost savings. The analytic subtleties associated with revenue
enhancements are whether one incurs (a) additional operating costsand/or (b) additional investments, to achieve
these enhancements, and ( c) the selection of a discount rate associated with the uncertainty of these
enhancements.

Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

Revenue Enhancements, Constant Dollars


Expected Inflation Rate
Growth Rate of FCF (nominal), in perpetuity
Discount Rate
Ongoing Investment/Revenue (year 1+)
Operating Cost/Revenues
Revenue Enhancements, Current Dollars
Operating Costs to Support Revenue Enhancements
Tax Expense (@ .40)
After-Tax Cost Savings
Less: Investment Necessary to Realize the Added Revenue
Plus: Disinvestment Associated with the Revenue
Subtotal
Terminal Value
Free Cash Flow

16 Net Present Value of Cost Savings


17 Internal Rate of Return of Synergy Investment

100 $
2%

200 $
2%

200 $
2%

200 $
2%

200
2%

102 $
(46)
(22)
34
(5)
10
39

208 $
(94)
(46)
69
(10)
5
63

212 $
(96)
(47)
70
(11)
59

216 $
(97)
(48)
71
(11)
61

221
(99)
(49)
73
(11)
62
531
593

3%
15%
5%
45%

(400)
(400)

(400) $
$50
18%

39

63

59

61

Financial Synergies
In a DCF framework, these synergies are most easily measured by changing the cost of capital of the buyer. As argued in the text of the
chapter, one must make a positive argument why the combination of buyer and target achieves financial synergies that investors cannot
duplicate on their own. This worksheet models two possible sources of financial synergies: (a) reduction in default risk on debt securities, and
(b) exploitation of low or negative covariance that investors cannot achieve. As the chapter suggests, claims about financial synergies are to be
approached skeptically and with caution.

Weighted average cost of capital, before the acquisition


Newco's weighted average cost of capital, after the acquisition
Total Capital of Buyer and Target, before the acquisition
Dollar Cost of Capital

Buyer (Before) Target (Before)


10.2%
11.2%
$
$

6,000
612

###
674 $

Implied Present Value of Financial Synergies from Acquisition


Calculation of Newco's Cost of Capital After Acquisition
Cost of Equity Estimate =
Beta of buyer, before the acquisition
Beta of target, before the acquisition
Unlevered Beta
Adjustment in Newco asset beta because of covariance unanticipated by market
Market value weight of buyer in Newco (%)
Market value weight of target in Newco (%)
Beta of Newco
Risk-Free Rate of Return
Equity market risk premium
Cost of equity from CAPM

0.05
0.07
12.0%

0.05
0.07
15.5%

Cost of Debt Estimate =


New rating associated with Newco's target capital structure
Average maturity of debt associated with target capital structure (in years)
Current pre-tax yields on debt, at rating and tenor of Newco
Marginal tax rate for Newco
After-tax cost of debt for Newco

4.8%
AA
7
8.0%
40.0%
4.8%

6.0%
BBB
7
10.0%
40.0%
6.0%

25%
75%

45%
55%

Weights in target capital structure for Newco


Targeted weight of debt (%)
Targeted weight of equity (%)

12.0%
1.00
0.83

Sum of
Buyer and
Target
(Before)
10.7%

15.5%
1.50
1.01

50%
50%

1,286