Valuation, mergers, and acquisitions.
Bandai Inc., the manufacturer of action toys (Power Rangers) is interested in acquiring Pac-Man Inc,, a manufacturer of video games. You have collected the following information on the two firms:
- Bandai reported after-tax operating income of $ 100 million on revenues of $ 2 billion in the most recent financial year. Its return on capital is 12% and it expects to maintain a growth rate of 3% a year in perpetuity.
- Pac-Man Inc reported after-tax operating income of $ 50 million on revenues of $ 1.5 billion in the most recent year. Its return on capital is 10% and it expects to maintain a growth rate of 3% a year in perpetuity. Both firms have a 9% cost of capital in perpetuity.
a. Estimate the value of Bandai as a stand-alone company.
b. Estimate the value of Pac-Man as a stand-alone company.
c. If Bandai acquires Pac-Man, it believes that it can increase the combined firm’s return on capital on existing investments to 12% and on new investments to 15% while holding the growth rate in perpetuity at 3%. Estimate the value of synergy in this merger.