Mergers and Acquisitions

Chapter 9
Alternative Approaches to Valuation

Two approaches:
1. Comparable Companies or Comparable Transactions
2. Discounted cash flow
a. spreadsheet
b. formula
Comparables
a.
b.
c.
d.

market/sales
market/book
market/income or P/E
market/EDITDA

Where market is
a. value prior to merger effects on price or
b. transactions price in previous mergers
Can be used for
a. Valuing private companies
b. Estimate transactions prices in event of merger
Discounted Cash Flow Approaches
Spreadsheet DCF methods equivalent to finding NPV of a
project, but larger scale.

Table 9.5 p. 231:

Revenues
- Cost
= Net Operating Income
- Taxes
= Net Op. Income After Tax
Investment requirements
Net Working Capital
Net Property Plant and Equipment
Free Cash Flow

Formula Approach
1. No growth:
CFAT/ k
2. Constant growth: CFAT(1+g)/k-g
3. Temporary supernormal growth, then no growth:
CFAT (1+g)t/(1+k)t + CFAT (1+g)n/k(1+k)n
4. Temporary Supernormal growth, then constant growth:
CFAT (1+g)t/(1+k)t + CFAT (1+g)n/(1+k)n * (1+g)/(kg)
All of thses are variations of constant growth model. Variation 3
discounts CFATs over supernormal period then PV of constant CFATs
to perpetuity. Similar for growth after supernormal growth in Variation
4.

Cost of capital:
1. Cost of equity:
CAPM basis
Bond rate plus risk premium
Dividend yield plus growth
2. Capital structure
Book
Market
3. Tax rate
Book expense
Tax paid
Merger premiums and DCF analysis
Benefits of synergies from combining companies vs.
Premium paid over market value to acquire.