1 Paxis plc will soon announce a takeover bid for Wragger plc, a company in the same indus

try. The initial bid will be

an all share bid of four Paxis shares for every five Wragger shares.

The most recent annual data relating to the two companies are shown below:

The takeover is expected to result in cost savings in advertising and distribution, reducing the operating costs

(including depreciation) of Paxis from 76% of sales to 70% of sales. The growth rate of the combined company is

expected to be 6% per year for four years, and 5% per year thereafter. Wragger’s debt obligations will be taken over

by Paxis. The corporate tax rate is expected to remain at 30%.

Sales and costs relevant to the decision may be assumed to be in cash terms.

Required:

(a) Using free cash flow analysis for each individual company and the potential combined company, estimate

how much synergy is expected to be created from the takeover. State clearly any assumptions that you make.

Note: The weighted average cost of capital of the combined company may be assumed to be the market weighted

average of the current costs of capital of the individual companies, weighted by the current market value of debt and

equity of the combined company, with the equity of Wragger adjusted for the effect of the bid price. (20 marks)