Table P10.2.1 uses Model 10-04 (from our Web sites) to calculate the premerger stand-alone values of Dow and Union Carbide. Dow had a higher net operating margin and a higher growth rate. Because of its higher credit rating it had a somewhat lower cost of capital. Analysts reports predicted that the combined operating margin would reflect the benefits of synergies in the total amount of $2 billion. They also predicted that the combined growth rate would raise Union Carbides growth rate toward the higher of Dow. In the combined column (Dow, the surviving company), of Table P10.2.1, are blanks for the operating income margins and growth rates for the initial period and the terminal period. Make your best estimate to fill in the blanks to calculate the values for the third column of the table.

TABLE P10.2.1 (Model 10-04) Dow-Union Carbide

Dow Union Carbide Combined (Dow)

Panel A Value Drivers

R0 = Base-year revenues $18,500 $6,000 $24,500

Super growth period

ms = Net operating income margin 10.0% 8.0%

Ts = Tax rate 35.0% 30.0% 32.0%

gs = Growth rate 8.6% 6.0%

ds = Depreciation 5.5% 5.5% 5.5%

Iws = Working capital requirements 1.0% 1.0% 2.0%

Ifs = Capital expenditures 4.0% 5.0% 5.0%

Ios = Change in other assets net 0.0% 0.0% 0.0%

ks = Cost of capital 9.0% 9.4% 9.6%

n = Number of super growth years 10 10 10

Terminal period

mc = Net operating income margin 7.1% 7.0%

Tc = Tax rate 35.0% 30.0% 32.0%

gc = Growth rate 4.0% 4.0%

dc = Depreciation 4.0% 4.0% 4.0%

Iwc = Working capital requirements 1.0% 1.0% 1.0%

Ifc = Capital expenditures 2.0% 3.0% 2.0%

Ioc = Change in other assets net 0.0% 0.0% 0.0%

kc = Cost of capital 9.0% 9.4% 9.6%

1 + h= calculation relationship = (1 + gs)/(1 + ks) 0.9963 0.9689

Panel BCalculating Values

Present value of super growth cash flows $12,691 $2,583

Present value of terminal value 20,923 4,129

Enterprise operating value $33,615 $6,712

Add: Marketable securities 267 267

Entity value $33,882 $6,712

Less: Total interest-bearing debt 5,900 2,200 8,100

Equity value $27,982 $4,512

Number of shares 660 133 660

Value per share $ 42.40 $33.93