You have been asked to value the synergy in a merger by your boss, who also happens to be an avid believer in Economic Value Added (EVA). As a result, you are given the following information on the two firms:

G & P is a diversified consumer product company with $ 2 billion in capital invested, a return on capital of 13%, and a cost of capital of 11%. The firm is assumed to be in stable growth, and the EVA is expected to grow 5% a year in perpetuity.

BandAdd is a smaller company that produces only perfumes. It has $ 500 million in capital invested, earning a return on capital of 16% with a cost of capital of 12%. This firm is also in stable growth, and the EVA is expected to grow 5% a year in perpetuity.

Both firms have 40% tax rates.

Using the above information, answer the following questions:

1. Value G & P using the EVA approach. ( 20 points)
2. Value BandAdd using the EVA approach. ( 20 points)
3. As a result of the merger, you expect the firm to be able to lower its cost of capital to 10% (as a result of increased debt capacity) and to post an increase in the combined operating income of 10% (as a result of economies of scale). Estimate the value of synergy in this merger. (60 points)

Note: $1,000 equals $1 billion on your spreadsheet.

a. Valuing G\&P Capital Invested = EVA created this year = PV of EVA = Value of Firm = \begin{tabular}{|r|r|} \hline 2000.00 & \\ \hline & 40.00 \\ \cline { 2 - 2 } & 156.00 \\ \cline { 2 - 2 } & 666.6666667 \\ \hline \end{tabular} b. Valuing BandAdd Capital Invested = EVA this year = PV of EVA = Value of Firm = c. Capital Invested = Combined Operating Income = 2500.00 Restated Operating Income = Restated EVA = PV of EVA, assuming 5% growth = New Firm Value = Value of Synergy = \begin{tabular}{|l|} \hline \\ \hline \\ \hline \\ \hline \\ \hline \\ \hline \end{tabular} Note: $1000=$1 billion