At the beginning of the year Ham Inc.’s management is considering making an offer to buy Egg Corporation. Egg’s
projected operating income (EBIT) for the current year is $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
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