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Using the information below, please answer question 7:

Abbott Lab's market value plunged more than $5 billion or 6% in a single day following the an- nouncement of the firm's acquisition of St. Jude Medical (St. Jude) on April 26, 2016, as investors expressed their disapproval. Their concern was that Abbot was overpaying and would be unable to arn financial returns demanded by investors. The $25-billion deal included a $6.5-billion premium 37% above St. Jude's closing price on April 25, 2016, St. Jude's shares soared by more than 27% boosting the firm's market capitalization to $24.1 billion from its level of $17.59 billion the prior day In announcing the transaction, Abbott said the primary motive for the takeover was to expand its heart device business. Abbott, the industry leader in manufacturing coronary stents and heart valve nted to combine with St. Jude, a maker of pacemakers and other devices for failing hearts. The aging population makes the "failing heart" market likely to show considerable growth in the coming years Medical equipment makers are under pressure to offer a wider portfolio of products to their hospital customers, which have been through a wave of mergers that have increased their power to negotiate pricing. With combined revenue of $8.7 billion, Abbott said its deal would help it compete more effectively against larger rivals Medtronic Plc, Boston Scientific Corp., and Edward Life Sci- ences. The combination of Abbott and St. Jude creates a medical device manufacturer with leadin positions in high-growth cardiovascular markets, including atrial fibrillation, structural heart, and heart failure, as well as a leading position in the high-growth neuromodulation market. The new firm also will have the largest pipeline (products in development) to deliver a steady stream of nev medical devices to these high-growth markets The definitive agreement reached by Abbott and St. Jude called for St. Jude shareholders to re eive $46.75 in cash and 0.8708 share of Abbott common stock. This represented a total consider ation of $85 per share. Abbott expects the deal would be accretive to earnings per share and that the combined firm will earn double-digit financial returns within 5 years. Management expects annual pretax cost savings of $500 million to begin within 5 years following closing. For the firm to cost savings beginning in 2020. Failure to realize these expected savings in a timely manner can impac significantly synergy value. Also, it is unclear if the full cost of realizing these synergies has beer earn the returns promised by management, it must be able to realize expe ed annual p tax deducted from the projected savings One way of determining if Abbott is overpaying is to estimate St. Jude's stand-alone value plus the PV of anticipated synergy. This estimate represents the upper limit (maximum) for the amount Abbott should pay for St. Jude and still be able to earn its cost of capital. Any payment in excess of the maximum purchase price means that Abbott is destroying shareholder value by in effect trans- ferring more value than would be created to the target firm shareholders. Table 8.5 provides data enabling an analyst to value St. Jude on a stand-alone basis using the comparable company method. Note that the table contains valuation multiples for St. Jude's three TABLE 8.5 St. Jude Medical Valuation Data Enterprise value to EBITDA, Col. 4 Enterprise value to revenue, Col. 5 Forward P/E", Price/revenueb, Price/book Col. 1 Col. 2 Col. 3 Primary competitors Medtronic (ratio) Boston Scientific (ratio) 18.04 Edward Life Sciences 29.28 (ratio) St. Jude Medical (dollars per share) 4.17 4.10 4.87 16.14 2.32 4.82 9.13 15.19 18.41 26.77 4.69 4.70 4.99 Earningsrevenu per share, $1.06 Book value/ share, $4.04 Enterpriserevenue value/ share, $1.12 share, $5.54 EBITDA, Earnings before interest, taxes, depreciation, and amortization; P/E, price-to-carnings S&P Capital Q report cmsensus estimate i4/26/16). Trailing 52-wrex average from S&P Capital TQ for period ending Manch 31, 2016 Most recent quarter(April 2, 2016). primary competitors as well as earnings, revenue, book value, and enterprise value per share for St. Jude. The choice of valuation multiples is subjective in that it is unclear which best mirror the stand- alone value of St. Jude's. Abnormally low interest rates at the time of the merger announcement could have resulted in artificially high valuation multiples. Also, the competitors selected are larger and more diversified than St. Jude's and their growth rates and profitability tend to be greater while the riskiness of their cash flows tends to be less. Discussion Questions 1. Based on the information provided in Table 8.5, what do you believe is a reasonable stand- alone value for St. Jude Medical? (Hint: Use the comparable company valuation method to derive a single point estimate of stand-alone value.) Show your work. 2. Does your answer to question (1) include a purchase price premium? Explain your answer 3. What are the key limitations of the comparable companies valuation methodology? Be specific. 4. In estimating the value of anticipated cost savings, should an analyst use St. Jude's marginal 5. What is the PV of the $500-million pretax annual cost savings expected to start in 2020? Assume the 6. What are the key valuation assumptions underlying the valuation of St. Jude Medical? Include 7. What is the maximum amount Abbott Labs could have paid for St. Jude Medical and still tax rate of 409, or its effective tax rate of 22%? Explain your answer. appropriate cost of capital is 10% and that the savings will continue in perpetuity. Show your work. both the valuation of St. Jude as a stand-alone business and synergy value. Be specific. earned its cost of capital? Did Abbott overpay for St. Jude based on the information given in the case? Explain your answer. [Hint: Use your answers to questions (1) and (5).] Abbott Lab's market value plunged more than $5 billion or 6% in a single day following the an- nouncement of the firm's acquisition of St. Jude Medical (St. Jude) on April 26, 2016, as investors expressed their disapproval. Their concern was that Abbot was overpaying and would be unable to arn financial returns demanded by investors. The $25-billion deal included a $6.5-billion premium 37% above St. Jude's closing price on April 25, 2016, St. Jude's shares soared by more than 27% boosting the firm's market capitalization to $24.1 billion from its level of $17.59 billion the prior day In announcing the transaction, Abbott said the primary motive for the takeover was to expand its heart device business. Abbott, the industry leader in manufacturing coronary stents and heart valve nted to combine with St. Jude, a maker of pacemakers and other devices for failing hearts. The aging population makes the "failing heart" market likely to show considerable growth in the coming years Medical equipment makers are under pressure to offer a wider portfolio of products to their hospital customers, which have been through a wave of mergers that have increased their power to negotiate pricing. With combined revenue of $8.7 billion, Abbott said its deal would help it compete more effectively against larger rivals Medtronic Plc, Boston Scientific Corp., and Edward Life Sci- ences. The combination of Abbott and St. Jude creates a medical device manufacturer with leadin positions in high-growth cardiovascular markets, including atrial fibrillation, structural heart, and heart failure, as well as a leading position in the high-growth neuromodulation market. The new firm also will have the largest pipeline (products in development) to deliver a steady stream of nev medical devices to these high-growth markets The definitive agreement reached by Abbott and St. Jude called for St. Jude shareholders to re eive $46.75 in cash and 0.8708 share of Abbott common stock. This represented a total consider ation of $85 per share. Abbott expects the deal would be accretive to earnings per share and that the combined firm will earn double-digit financial returns within 5 years. Management expects annual pretax cost savings of $500 million to begin within 5 years following closing. For the firm to cost savings beginning in 2020. Failure to realize these expected savings in a timely manner can impac significantly synergy value. Also, it is unclear if the full cost of realizing these synergies has beer earn the returns promised by management, it must be able to realize expe ed annual p tax deducted from the projected savings One way of determining if Abbott is overpaying is to estimate St. Jude's stand-alone value plus the PV of anticipated synergy. This estimate represents the upper limit (maximum) for the amount Abbott should pay for St. Jude and still be able to earn its cost of capital. Any payment in excess of the maximum purchase price means that Abbott is destroying shareholder value by in effect trans- ferring more value than would be created to the target firm shareholders. Table 8.5 provides data enabling an analyst to value St. Jude on a stand-alone basis using the comparable company method. Note that the table contains valuation multiples for St. Jude's three TABLE 8.5 St. Jude Medical Valuation Data Enterprise value to EBITDA, Col. 4 Enterprise value to revenue, Col. 5 Forward P/E", Price/revenueb, Price/book Col. 1 Col. 2 Col. 3 Primary competitors Medtronic (ratio) Boston Scientific (ratio) 18.04 Edward Life Sciences 29.28 (ratio) St. Jude Medical (dollars per share) 4.17 4.10 4.87 16.14 2.32 4.82 9.13 15.19 18.41 26.77 4.69 4.70 4.99 Earningsrevenu per share, $1.06 Book value/ share, $4.04 Enterpriserevenue value/ share, $1.12 share, $5.54 EBITDA, Earnings before interest, taxes, depreciation, and amortization; P/E, price-to-carnings S&P Capital Q report cmsensus estimate i4/26/16). Trailing 52-wrex average from S&P Capital TQ for period ending Manch 31, 2016 Most recent quarter(April 2, 2016). primary competitors as well as earnings, revenue, book value, and enterprise value per share for St. Jude. The choice of valuation multiples is subjective in that it is unclear which best mirror the stand- alone value of St. Jude's. Abnormally low interest rates at the time of the merger announcement could have resulted in artificially high valuation multiples. Also, the competitors selected are larger and more diversified than St. Jude's and their growth rates and profitability tend to be greater while the riskiness of their cash flows tends to be less. Discussion Questions 1. Based on the information provided in Table 8.5, what do you believe is a reasonable stand- alone value for St. Jude Medical? (Hint: Use the comparable company valuation method to derive a single point estimate of stand-alone value.) Show your work. 2. Does your answer to question (1) include a purchase price premium? Explain your answer 3. What are the key limitations of the comparable companies valuation methodology? Be specific. 4. In estimating the value of anticipated cost savings, should an analyst use St. Jude's marginal 5. What is the PV of the $500-million pretax annual cost savings expected to start in 2020? Assume the 6. What are the key valuation assumptions underlying the valuation of St. Jude Medical? Include 7. What is the maximum amount Abbott Labs could have paid for St. Jude Medical and still tax rate of 409, or its effective tax rate of 22%? Explain your answer. appropriate cost of capital is 10% and that the savings will continue in perpetuity. Show your work. both the valuation of St. Jude as a stand-alone business and synergy value. Be specific. earned its cost of capital? Did Abbott overpay for St. Jude based on the information given in the case? Explain your answer. [Hint: Use your answers to questions (1) and (5).]