BNYC and Mellons Merger, Grp-11, MACR-B

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 increase in the equity will leave some leeway for the debt which can be used to get additional debt. 4. Under the terms of the proposed deal, what fraction of the synergies will be captured by Mellon legacy shareholders? By BNY legacy shareholders? (Legacy shareholders are the former shareholders of BNY or Mellon after they become shareholders of the new company.) Ans: refer to the spreadsheet. 5. Based on the last closing stock prices and assuming no synergies what exchange ratio would leave the per share values of Mellon and BNY stock the same? (The zero premium exchange ratio.) How does the actual exchange ratio differ from this number? Who benefits from the difference? Ans: This will be 35.48/40.05 i.e. 1:0.889 for BNYC and 1:1 for Mellon. The actual exchange ratio is 1:0.9434 for BNYC and 1:1 for Mellon. In that case, BNYC will benefit from the difference. 6. In the absence of synergies, what exchange ratio would keep the earnings attributed to each legacy share in Q4 2007 equal before and after the merger? Ans: In this case we have on the left hand side the ratio of EPS for BNYC and Mellon for Q4 of 2006 and on the right hand side we have product of (the ratio of EPS for both the banks), (ratio of current share prices of BNYC and Mellons) and (the current exchange ratio). By solving the equation we get an exchange ratio of 0.997.

7. In the absence of synergies is the proposed deal accretive or dilutive for Mellon shareholders? For BNY shareholders? Ans: Dilutive for Mellon shareholders and for BNYC it will be accretive. 8. How do synergies impact accretion/ dilution analysis? Ans: With synergies the impact of accretion is further magnified through greater earnings per share and dilution is reduced by a similar increase in the EPS. 9. 10. In the negotiations with BNY should Kelly have held out for an exchange ratio that is more favorable to Mellon? Is he selling out the shareholders of Mellon and the city of Pittsburgh by doing the deal on disadvantageous terms? Ans: No, because the forecast of EPS in Exhibit 16 at the current agreement does not indicate any loss to Mellon shareholders compared to the case of no mergers. Though, in this case the synergies are more evenly distributed across both the entities compared to the case where exchange ratio equals the ratio of recent stock prices. The city of Pittsburg will be getting more jobs and the community services are well taken care of even before the merger takes places.