Lecture 8 Workshop Questions:
Q1
Suppose Microsoft Corportation (MSFT), the largest software company in the world wants to acquire Exxon Mobil (XOM) the largest oil and gas company in the world. Microsoft is currently trading at $25.96 and Exxon-Mobil at $38.31 per share. Microsoft’s earnings are at $9.6 billion, and Exxon’s, at $15.4 billion. Synergies of $1.25 billion are expected. Shares outstanding are 10.7 billion and 6.68 billion for Microsoft and Exxon, respectively.
a) What minimum price/earnings ratio for the new company (i.e. the acquired
group) will make a deal justifiable for both parties?
Suppose Exxon Mobil thinks Newco will trade at a P/E ratio of 22 times and that Bill Gates says, “How can Exxon think that by merging with us it can raise it P/E to 22 times? Microsoft thinks that the new company will only trade at 18 times. If Exxon Mobil wants to make the deal work, it needs to convince Microsoft to increase its P/E estimate for the new company.”
b) Without changing its own view that the post-merger P/E will be 22 times, what
P/E level must Exxon Mobil convince Microsoft that the new company will trade at in order for Microsoft to agree to the deal?
Q2
The following are the details on two potential merger candidates, Northrop and Grumman, in 1993:
Northrop Grumman
Revenue $4,400 $3,125
COGS (w/o depreciation) 87.5% 89.0%
Depreciation $200 $74
Tax Rate 35% 35%
Working Capital 10% of Revenue 10% of Revenue
Market Value of Equity $2000 $1300
Outstanding Debt $160 $250
Both firms are in steady state and are expected to grow 5% a year in the long term. Capital spending is expected to grow at the same rate and be offset by depreciation. The cost of debt for both companies is s 8.5%. The cost of equity is 12.5%. As a result of the merger, the combined firm is expected to have a COGS of only 86% of total revenues. The combined firm does not plan to borrow additional debt.
a)Estimate the value of Grumman, operating independently
b) Estimate the value of Northrop, operating independently
c) Estimate the value of the combined firm, with no synergy
d) Estimate the value of the combined firm, with synergy
e) How much is the operating synergy worth?