Mellon Case Study

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1. What is the value of the cost saving synergies created by the deal? Assume that a. The combined company will have a tax rate of 38%; b. Deposits, Short-term Borrowings, Long Term Debt and Equity are part of a bank’s capital structure: “Other liabilities are not”; c. An aggregate debt beta of 0.1 is a reasonable estimate of the average beta of debt that supports the assets that give rise to the merger’s synergies; d. The equity betas reported in Exhibit 2 may be used as estimates for the betas of the equity that supports the assets that give rise to the synergies: and e. The market risk premium is 6.2% Ans: Refer to spreadsheet. 2. How much confidence do you have in your estimate of synergies? Ans: In this case we are allocating the cost savings to both the entities separately in terms of the extra EPS in case of synergies for each and then valuing them with their respective WACCs. We are assuming the cost savings would be utilized in their respective companies. Also, for the onetime cost for the merger, we are discounting it at a rate which is the average of WACCs of both the companies. By doing this we are ensuring that, i) The cash flows are discounted at the rate at which they are going to be invested. ii) The two entities have different betas, which means we should use different WACCs for the cost savings from each of them. iii) For the onetime costs we do not have enough data to calculate the company wise expenses so, we discount it at a rate that seems reasonable. In this case which we have assumed to be the mean of the WACCs of the two entities. 3. Will synergy cash-flows allow the banks to increase their debt? Ans: Since, cost synergies will not change the book values of equities for the merged entity, but they will be transferred to the retained earnings which will increase the overall equity. By an

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