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Handout Problem 1 - The Value of Synergy: Cost Savings Example The following are the details on two potential merger candidates, Northrop and Grumman: Both firms are in steady state and are expected to grow 5% a year in the long term. The beta for both firms is 1 , and both firms are rated A+, with an interest rate on their debt of 8.5%. (The treasury bond rate is 7%, the market risk premium is 5.5% ) As a result of the merger, the combined firm is expected to have a cost of goods sold of only 86% of total revenues. The combined firm does not plan to borrow additional debt. Both firms are in steady state and are expected to grow 5% a year in the long term. The beta for both firms is 1 , and both firms are rated A+, with an interest rate on their debt of 8.5%. (The treasury bond rate is 7%, the market risk premium is 5.5% ) As a result of the merger, the combined firm is expected to have a cost of goods sold of only 86% of total revenues. The combined firm does not plan to borrow additional debt. A. Estimate the value of Northrop, operating independently. B. Estimate the value of Grumman, operating independently. C. Estimate the value of the combined firm, with no synergy. D. Estimate the value of the combined firm, with synergy. E. How much is the operating synergy worth

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