Question at position 1 PharmaCo has a capital structure consisting of $14 billion in market equity and $2 billion in outstanding debt. The firm expects to generate free cash flows of $1.4 billion next year, which are projected to grow at 3% per year in perpetuity. PharmaCo currently holds $3.6 billion in excess cash, which it plans to use entirely to finance an acquisition. Their cost of debt and equity are 3% and 7% respectively. BioEdge has $2.5 billion in market equity and $1.5 billion in debt. The firm is expected to generate $285 million in free cash flows next year, growing at 3% per year in perpetuity. BioEdge has 100 million shares outstanding, currently trading at $25 per share. Their cost of debt and equity are 8% and 13% respectively. PharmaCo is offering to acquire BioEdge using $3.6 billion in internal cash reserves. The merger is expected to generate $25 million in additional free cash flows next year, entirely from operational improvements in BioEdge, which will grow at 4% per year in perpetuity. Both firms are subject to corporate tax rate of 30%. What is the equity value of the merged firm after the transaction (in billions)?PharmaCo has a capital structure consisting of $14 billion in market equity and $2 billion in outstanding debt. The firm expects to generate free cash flows of $1.4 billion next year, which are projected to grow at 3% per year in perpetuity. PharmaCo currently holds $3.6 billion in excess cash, which it plans to use entirely to finance an acquisition. Their cost of debt and equity are 3% and 7% respectively. BioEdge has $2.5 billion in market equity and $1.5 billion in debt. The firm is expected to generate $285 million in free cash flows next year, growing at 3% per year in perpetuity. BioEdge has 100 million shares outstanding, currently trading at $25 per share. Their cost of debt and equity are 8% and 13% respectively. PharmaCo is offering to acquire BioEdge using $3.6 billion in internal cash reserves. The merger is expected to generate $25 million in additional free cash flows next year, entirely from operational improvements in BioEdge, which will grow at 4% per year in perpetuity. Both firms are subject to corporate tax rate of 30%. What is the equity value of the merged firm after the transaction (in billions)?34.638.627.620.6题目解析单项选择题
A
34.6
B
38.6
C
27.6
D
20.6

Question

Question at position 1 PharmaCo has a capital structure consisting of $14 billion in market equity and $2 billion in outstanding debt. The firm expects to generate free cash flows of $1.4 billion next year, which are projected to grow at 3% per year in perpetuity. PharmaCo currently holds $3.6 billion in excess cash, which it plans to use entirely to finance an acquisition. Their cost of debt and equity are 3% and 7% respectively. BioEdge has $2.5 billion in market equity and $1.5 billion in debt. The firm is expected to generate $285 million in free cash flows next year, growing at 3% per year in perpetuity. BioEdge has 100 million shares outstanding, currently trading at $25 per share. Their cost of debt and equity are 8% and 13% respectively. PharmaCo is offering to acquire BioEdge using $3.6 billion in internal cash reserves. The merger is expected to generate $25 million in additional free cash flows next year, entirely from operational improvements in BioEdge, which will grow at 4% per year in perpetuity. Both firms are subject to corporate tax rate of 30%. What is the equity value of the merged firm after the transaction (in billions)?PharmaCo has a capital structure consisting of $14 billion in market equity and $2 billion in outstanding debt. The firm expects to generate free cash flows of $1.4 billion next year, which are projected to grow at 3% per year in perpetuity. PharmaCo currently holds $3.6 billion in excess cash, which it plans to use entirely to finance an acquisition. Their cost of debt and equity are 3% and 7% respectively. BioEdge has $2.5 billion in market equity and $1.5 billion in debt. The firm is expected to generate $285 million in free cash flows next year, growing at 3% per year in perpetuity. BioEdge has 100 million shares outstanding, currently trading at $25 per share. Their cost of debt and equity are 8% and 13% respectively. PharmaCo is offering to acquire BioEdge using $3.6 billion in internal cash reserves. The merger is expected to generate $25 million in additional free cash flows next year, entirely from operational improvements in BioEdge, which will grow at 4% per year in perpetuity. Both firms are subject to corporate tax rate of 30%. What is the equity value of the merged firm after the transaction (in billions)?34.638.627.620.6题目解析单项选择题

A

34.6

B

38.6

C

27.6

D

20.6

BlackTom AI · Accepted Answer

Question restatement:
PharmaCo and BioEdge are evaluating a merger. PharmaCo has market equity of $14B and debt of $2B. Free cash flow (FCF) next year is $1.4B, growing at 3% perpetually. PharmaCo has $3.6B in excess cash to finance an acquisition. Cost of debt is 3% and cost of equity is 7%. BioEdge has market equity of $2.5B and debt of $1.5B. BioEdge FCF next year is $285M, growing at 3% perpetually. BioEdge has 100M shares outstanding at $25 each. Cost of debt is 8% and cost of equity is 13%. PharmaCo will acquire BioEdge using the $3.6B internal cash. The merger adds $25M of FCF next year from operational improvements in BioEdge, growing at 4% perpetually. Tax rate is 30%. Question: What is the equity value of the merged firm after the transaction (in billions)? Options: 34.6, 38.6, 27.6, 20.6.

Option-by-option analysis:

Option 1: 34.6
- Why this could be considered: This value is in the same general ballpark as a post-merger equity value that adds together the standalone equity bases and some portion of the synergy value, but tends to underestimate the full value contribution of the merger.
- What’s likely overlooked or misapplied: It underweights the incremental value from the merger synergies (the $25M of additional FCF growing at 4% forever) and any potential re-rating effects or tax-shield impacts that the combined capital structure could generate. If you only add base values and ignore or discount the synergy PV, you end up with a too-low figure. Also, the use of internal cash to finance acquisition reduces the cash cushion but does not fully eliminate the value created by the synergy, so a value around 34.6 would require understating the synergy’s present value.

Option 2: 38.6
- Why this could be the correct valuation: This figure likely reflects incorporating the value of the merger synergy more fully. The $25M per year of additional FCF from operational improvements, growing at 4%, has a positive present value that, when added to the standalone equity values and adjusted for the financing via internal cash, can push the equity value into the 38.6B region. Additionally, after-tax cash flows and the combined tax shield from debt may contribute to a higher overall value, consistent with a robust post-merger equity value.
- What makes this plausible: If you correctly value the base FCF streams (PharmaCo and BioEdge) at their appropriate WACC (accounting for the tax shield) and add the incremental synergy FCF PV, the total equity value after the transaction can land higher, particularly when you account for the financing method (using internal cash) and the growth paths in perpetuity. This option aligns with a scenario where synergy and combined scale significantly lift value beyond the standalone equities.

Option 3: 27.6
- Why this could be considered: This is on the lower side and would occur if one substantially discounts the synergy value or assumes a much higher cost of capital, or if the post-merger equity base is treated as smaller due to aggressive debt usage or mis-accounting of synergies.
- What’s wrong here: A too-small number suggests either omitting the $25M per year of synergy, underestimating its perpetuity value (even at moderate WACC, a 25M perpetual annuity can contribute meaningfully) or misapplying the tax effects and debt-related benefits. Given the sizable standalone equity bases and the added synergy, 27.6 lacks justification unless several key values are forced down unrealistically.

Option 4: 20.6
- Why this could be considered: A value this low would require a very pessimistic assessment of the merger, perhaps assuming a high effective cost of capital, overwhelming negative impacts from integration, or a misallocation of cash (e.g., treating the 3.6B cash as creating no value via synergy and discounting aggressively).
- What’s wrong here: It ignores the substantial ongoing cash flow improvements from the merger and likely understates the present value of the synergy. It also implies either an extremely high discount rate or miscounting other benefits, which is inconsistent with the given data (perpetuity growth, tax rate, and known cash flow increments). In short, it undervalues the merger to a degree that would be surprising given the stated inputs.

Summary takeaway for which option best fits the provided data:
- The problem provides a sizable base of FCFs for both firms, a credible synergy of $25M growing at 4%, a modest tax rate, and a financing plan using internal cash rather than external funding. These elements together typically push the post-merger equity value into the mid-to-high 30s of billions, making 38.6 the most plausible value among the options provided. The lower values tend to rely on undercounting the synergy or applying zero/negative effects to it, while 34.6 would require a heavier discounting of benefits than the data suggest. Conversely, 20.6 would require an unlikely combination of extreme assumptions.