Question
At the beginning of the year Cheese Inc.'s management is considering making an offer to buy Soup Corporation. Soup's projected operating income (EBIT) for the
At the beginning of the year Cheese Inc.'s management is considering making an offer to buy Soup Corporation. Soup's projected operating income (EBIT) for the current year is $40 million, but Cheese believes that if the two firms were merged, it could consolidate some operations, reduce Soup's expenses, and raise its EBIT to $58 million. Neither company uses any debt, and they both pay income taxes at a 40% rate. Cheese has a better reputation among investors, who regard it as better managed and also less risky, and its stock has a P/E ratio of 16 versus a P/E of 12 for Soup. Since Cheese's management will be running the entire enterprise after a merger, investors will value the resulting corporation based on Cheese's P/E. Based on expected market values, how much synergy should the merger create? Show your calculations, if any, and explain your answer.
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