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Case 2: Synergy in a merger..
Aswath Damodaran
37
We valued Harman Interna
Ional for an acquisiIon by Tata Motors and
esImated a value of $ 2,476 million for the operaIng assets and $ 2,678
million for the equity in the firm, concluding that it would not be a value
creaIng acquisiIon at its current market capitalizaIon of $5,248 million.
In es
ImaIng this value, though, we treated Harman
Interna
Ional as a
standalone firm.
Assume that Tata Motors foresees potenIal synergies in the combinaIon
of the two firms, primarily from using its using Harman’s highend audio
technology (speakers, tuners) as opIonal upgrades for customers buying
new Tata Motors cars in India. To value this synergy, let us assume the
following:
It will take Tata Motors approximately 3 years to adapt Harman’s products to Tata
Motors cars.
Tata Motors will be able to generate Rs 10 billion in a
Rertax operaIng income in
year 4 from selling Harman audio upgrades to its Indian customers, growing at a
rate of 4% a year aRer that in perpetuity (but only in India).


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EsImaIng the cost of capital to use in valuing
synergy..
Aswath Damodaran
38
Business risk
: The perceived synergies flow from opIonal addons
in auto sales. We will begin with the levered beta of 1.10, that we
esImated for Tata Motors in chapter 4, in esImaIng the cost of
equity.
Geographic risk
: The second is that the synergies are expected to
come from India; consequently, we will add the country risk
premium of 3.60% for India, es
Imated in chapter 4 (for Tata
Motors) to the mature market premium of 5.5%.
Debt raIo
: Finally, we will assume that the expansion will be
enIrely in
India, with Tata Motors maintain its exis
Ing debt to
capital raIo of 29.28% and its current rupee cost of debt of 9.6%
and its marginal tax rate of 32.45%.
Cost of equity in Rupees = 6.57% + 1.10 (5.5%+3.60%) = 16.59%
Cost of debt in Rupees = 9.6% (1.3245) = 6.50%
Cost of capital in Rupees = 16.59% (1.2928) + 6.50% (.2928) = 13.63%


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EsImaIng the value of synergy… and what Tata
can pay for Harman
Aswath Damodaran
39
Value of synergy
Year 3
=
Value of synergy today =
ConverIng the synergy value into dollar terms at the prevailing
exchange rate of Rs 60/$, we can esImate a dollar value for the
synergy from the potenIal acquisiIon:
Value of synergy in US $ = Rs 70,753/60 = $ 1,179 million
Adding this value to the intrinsic value of $2,678 million that we
esImated for Harman’s equity in chapter 5, we get a total value for
the equity of $3,857 million.
Value of Harman = $2,678 million + $1,179 million = $3,857 million
Since Harman’s equity trades at $5,248 million, the acquisiIon sIll
does not make sense, even with the synergy incorporated into
value.
Expected Cash Flow
Year 4
(Cost of Capital - g)
=
10,000
(.1363-.04)
=
Rs 103,814 million
Value of Synergy
year 3
(1+Cost of Capital)
3
=
103,814
(1.1363)
3
=
Rs 70,753 million


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