In early 2011 Ham Inc.'s management was considering making an offer to buy Egg Corporation. Egg's projected operating income (EBIT) for 2011 was $30 million, but Ham believes that if the two firms were merged, it could consolidate some operations, reduce Egg's expenses, and raise its EBIT to $40 million. Neither company uses any debt, and they both pay income taxes at a 40% rate. Ham has a better reputation among investors, who regard it as better managed and also less risky, so Ham's stock has a P/E ratio of 15 versus a P/E of 12 for Egg. Since Ham's management will be running the entire enterprise after a merger, investors will value the resulting corporation based on Ham's P/E. Based on expected market values, how much synergy should the merger create?
A) $129.96
B) $136.80
C) $144.00
D) $151.20
E) $158.76

Question

Quizplus · Accepted Answer

The synergy created by the merger is the increase in EBIT from $30 million to $40 million, which is $10 million. With a tax rate of 40%, the after-tax increase is $6 million. Using Ham's P/E ratio of 15, the value of this synergy is 15 * $6 million = $90 million.

In Early 2011 Ham Inc