The managers of State Bank have been approached by City Bank about a possible merger. State Bank is asking a price of $205 million to be purchased by City Bank. State Bank currently has total cash flows of $15 million that are expected to grow at 1 percent annually for the next two years. Managers are uncertain of the growth in State Bank’s cash flows in year 3. Managers estimate that because of synergies the merged firm’s cash flows will increase by an additional $1.5 million in the first year after the merger and these cash flows will grow by 5 percent in years 2 and 3 following the merger. Managers have estimated that the present value of any incremental cash flows received after year three is $158.75 million. The WACC for the merged firms is 8 percent. Calculate State Bank’s minimum incremental cash flow needed in year 3 after the merger such that City Bank would see this merger as a positive NPV project.
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