The managers of State Bank have been approached by City Bank about a possible merger.State Bank is asking a price of $171.78 million to be purchased by City Bank.City Bank currently has total cash flows of $30 million that are growing at 2 percent annually.Managers of State Bank estimate that because of synergies the merged firm's cash flows will increase by an additional 6 percent for the first four years following the merger.After the first four years,managers of State Bank have estimated that incremental cash flows will grow at a rate of 3 percent.The WACC for the merged firms is 11 percent.Managers of City Bank agree that cash flows should grow at an additional 6 percent for the first four years,but are unsure of the long-term growth rate in incremental cash flows estimated by City Bank.Calculate the minimum growth rate needed after the first four years such that City Bank would see this merger as a positive NPV project.

Question

Quizplus · Accepted Answer

The correct answer is A.The minimum growth rate needed after the first four years such that City Bank would see this merger as a positive NPV project is 7.26 percent. This is because the WACC for the merged firms is 11 percent, and the incremental cash flows are expected to grow at a rate of 6 percent for the first four years and 3 percent thereafter. Therefore, the minimum growth rate needed after the first four years such that City Bank would see this merger as a positive NPV project is 11 percent - 6 percent = 7.26 percent.

The Managers of State Bank Have Been Approached by City