FINANCIAL

MANAGEMENT
TOPIC 5
PRESENTED BY: MYLENE SALVADOR
TOPICS:

• MERGERS, ACQUISITION, AND RESTRUCTURING

• CORPORATE VALUATION MODELS
• VALUE OF A FIRM
• CAPITAL MARKET EFFICIENCY
• EFFICIENCY FOR CORPORATE FINANCE
• SOURCES OF LONG TERM FINANCE
 MERGERS, ACQUISITIONS AND RESTRUCTURING

MERGERS – The combination of two or more companies in which only one firm
survives as a legal entity.
ACQUISITION is one company taken over by the other.
RESTRUCTURING - Corporate restructuring is a corporate action taken to
significantly modify the structure or the operations of the company. This usually
happens when a company faces significant problems and is in financial jeopardy.
Corporate restructuring is essential to eliminate all possible financial troubles and
improve the performance of the company.
PHINMA
CORPORATION
 RATIONALE FOR M & A AND RESTRUCTURING

1. Synergy / Value Creation

The primary motivation for most mergers is to increase the value of the combined
enterprise. If companies A and B merge to form Company C, and if C’s value exceeds that
of A and B taken separately, then synergy is said to exist.
Mergers and acquisitions (M&A) increase the value of a firm through the creation of
synergies. These synergies can take many forms such as higher prices due to reduced
competition, increased sales from improved distribution, lower operating costs because of
economies of scale, tax savings from loss carry forwards, or improved strategic and
financial management.
 RATIONALE

2. Tax Considerations
Tax considerations have stimulated a number of mergers.
For example, a profitable firm in the highest tax bracket could
acquire a firm with large accumulated tax losses. These losses could
then be turned into immediate tax savings rather than carried
forward and used in the future.
 RATIONALE

3. Purchase of Assets Below their Replacement Cost

Sometimes a firm will be touted as an acquisition candidate because
the cost of replacing its assets is considerably higher than its market
value.
For example, oil companies could acquire reserves cheaper by
buying other oil companies than by conducting exploratory drilling.
( CHEVRON – GULF OIL)
 RATIONALE

4. Improved Management
Some companies are inefficiently managed, with the result that
profitability is lower than it might otherwise be. Restructuring can provide
better management.
5. Information Effect
Value could also occur if new information is conveyed as a result of
restructuring. If the stock is believed to be undervalued, a positive signal
may occur which causes the share price to rise.
 ECONOMIES OF SCALE
Economies of Scale may be possible with a merger of two companies. It is the benefits of
size in which the average cost declines as volume increases.
Economies can be realized with a HORIZONTAL MERGER, combining two companies in
the same line of business.
VERTICAL MERGER occurs when two or more firms, operating at different levels within
an industry's supply chain, merge operations. Most often the logic behind the merger is to
increase synergies created by merging firms that would be more efficient operating as one.
CONGLOMERATE MERGER occurs when unrelated enterprises combine.
PURCHASE OF ASSETS OR COMMON STOCK

A company may be acquired by the purchase either of its assets or

of its common stock. The buying company may purchase all or a
portion of the assets of another company and pay for them in cash
or with its own common stock. Frequently, the buyer acquires
only the assets of the other company and does not assume its
liabilities.
CORPORATE VALUATION MODELS

Valuation models are used to determine the worth or fair

value of a company. Analysts take dozens of factors into
consideration depending on the valuation method used,
including income statements, balance sheets, market
conditions, business models, and management teams.
 INTRINSIC AND RELATIVE VALUATION

Intrinsic Valuation involves going beyond market value to include other

intangible factors that may impact a company's true current and future
worth, like patents and brand recognition. It uses fundamental analysis to
look at both qualitative and quantitive factors. Intrinsic valuation is also
called absolute valuation.
Relative valuation attempts to determine the worth of a business based
on where it stands compared to other companies in the same industry.
VALUATION MODELS
 ABSOLUTE VALUATION TECHNIQUES

Discounted Cash Flow (DCF)

The goal of DCF is to estimate the future cash flow of a given business to
understand whether an investment will generate a positive return.
The DCF is often compared with the initial investment. If the DCF is
greater than the present cost, the investment is profitable. The higher the
DCF, the greater return the investment generates. If the DCF is lower
than the present cost, investors should rather hold the cash.
DISCOUNTED CASH FLOW (DCF)

DCF analysis takes into consideration the time value of money in a

compounding setting. After forecasting the future cash flows and
determining the discount rate, DCF can be calculated through the formula
below:
DISCOUNTED CASH FLOW (DCF) EXAMPLE

A company requires a $150,000 initial investment for a project that is

expected to generate cash inflows for the next five years. It will generate
$10,000 in the first two years, $15,000 in the third year, $25,000 in the
fourth year, and $20,000 with a terminal value of $100,000 in the fifth
year. Assuming the cost of capital is 5%, and no further investment is
required during the term, the DCF of the project can be calculated as
below:
DISCOUNTED CASH FLOW (DCF) EXAMPLE

Without considering the time value of money, this project will create a total
cash return of $180,000 after five years, higher than the initial investment of
$150,000, which seems to be profitable. However, after discounting the cash
flow of each period, the present value of the return is only $146,142, lower
than the initial investment of $150,000. It suggests the company should not
invest in the project.
 RELATIVE VALUATION TECHNIQUES

Comparable Company Analysis (COMPS)

is a relative valuation method in which you compare the current value of
a business to other similar businesses by looking at trading multiples like
Price to Earnings P/E, Enterprise Value to Earnings before Interest ,
Taxes, Depreciation and Amortization EV/EBITDA, or other ratios.
RELATIVE VALUATION TECHNIQUES

Comparable Company Analysis (COMPS)

RELATIVE VALUATION TECHNIQUES

Cost Approach
The cost approach, which is not as commonly used in corporate
finance, looks at what it actually costs or would cost to rebuild
the business. This approach ignores any value creation or cash
flow generation and only looks at things through the lens of
“cost = value.”
 VALUE OF A FIRM

A firm’s value, also known as Firm Value (FV), Enterprise Value (EV). It is
an economic concept that reflects the value of a business. It is the value
that a business is worthy of at a particular date.
Theoretically, it is an amount that one needs to pay to buy/take over a
business entity. Like an asset, the value of a firm can be determined on the
basis of either book value or market value. But generally, it refers to the
market value of a company.
 CALCULATING A FIRM’S VALUE

The value of a firm is basically the sum of claims of its creditors and
shareholders. Therefore, one of the simplest ways to measure it is by
adding the market value of its debt, equity, and minority interest. Cash and
cash equivalents would then be deducted to arrive at the net value.
EV = market value of common equity + market value of preferred
equity + market value of debt + minority interest – cash and
investments.
 CALCULATING A FIRM’S VALUE ( FREE CASH FLOWS)

Another sound approach for computing the value of a firm is to determine the
present value of its future operating free cash flows. The idea is to draw a
comparison between two similar firms. The firm whose present value of future
operating cash flows is better than the other is more likely to attract a higher
valuation from the investors.
Formula for Computing Operating Free Cash Flow (OFCF )
OFCF = EBIT (1-T) + Depreciation – CAPEX – working capital – any other
assets
 CALCULATING A FIRM’S VALUE ( FREE CASH FLOWS)

Formula for Computing Operating Free Cash Flow (OFCF )

OFCF = EBIT (1-T) + Depreciation – CAPEX – working capital – any other
assets
Where,
EBIT = earnings before interest and taxes,
T = tax rate
CAPEX = capital expenditure
 BOOK VALUE AND MARKET VALUE OF A FIRM

The firm’s book value is its value as reflected in its ‘books’ or financial
statements. It is the difference between the assets and liabilities of a firm as
per its balance sheet. It is the shareholder’s equity in the balance sheet. This
is the true worth of a business when its liabilities are net off from its assets.
The market value of a company, also known as market capitalization, is its
value as reflected in the stock exchange. It is calculated by multiplying a
company’s outstanding share by its current market price.
 CAPITAL MARKET EFFICIENCY

Market efficiency is the extent to which stock prices indicate the

available, relevant information. In an efficient capital market,
security prices adjust rapidly to the arrival of new information,
therefore the current prices of securities reflect all information
about the security.
 WHY SHOULD CAPITAL MARKETS BE EFFICIENT

The premises of an efficient market

• A large number of competing profit-maximizing participants analyze and value
securities, each independently of the others.
• New information regarding securities comes to the market in a random fashion
• Profit maximizing investors adjust security prices rapidly to reflect the effect of
new information.
Conclusion: the expected returns implicit in the current price of a security should
reflect its risks.
 CAPITAL MARKET EFFICIENCY

Example
The Time lag from information dissemination to change in security
prices.
Example: Suppose a company X announces that it will have an
increase in the price of its products and this has an immediate effect
on the security’s price then we say that the market is efficient.
EFFICIENT MARKET HYPOTHESIS (EMH)

1. Weak Form EMH – prices reflect all security-market

information
2. Semi-Strong EMH – prices reflect all public
information
3. Strong EMH – prices reflect all public and private
information
• The weak form suggests today’s stock prices reflect all the data of past
prices and that no form of technical analysis can aid investors.
• The semi-strong form submits that because public information is part of a
stock's current price, investors cannot utilize either technical or fundamental
analysis, though information not available to the public can help investors.
• The strong form version states that all information, public and not public, is
completely accounted for in current stock prices, and no type of information
can give an investor an advantage on the market.
 LONG TERM FINANCE AND SOURCES
Long-term financing means financing by loan or borrowing for a term of more than one
year by issuing equity shares, a form of debt financing, long-term loans, leases, or bonds.
Purpose for which long term finance is availed
• To finance fixed assets
• Expansion of companies
• Increasing facilities
• Acquisition of companies
 SOURCES OF LONG-TERM FINANCING
1. Equity Shares
Equity Shares, also known as ordinary shares, represent the ownership
capital in a company. The holders of these shares are the legal owners of
the company. They have unrestricted claim on income and assets of the
company and possess all the voting power in the company.
 SOURCES OF LONG-TERM FINANCING
2. Preference Shares
Preference share capital is another source of long-term financing for a
company. These shares carry preferential rights over equity shares both
regarding the payment of dividend and the return of capital. These shares
carry a fixed rate of dividend and such dividend must be paid in full before
the payment of any dividend on equity shares. Similarly, at the time of
liquidation, the whole of preference capital must be paid before any payment
is made to equity shareholders.
 SOURCES OF LONG-TERM FINANCING
3. Debentures:
Debentures are one of the frequently used methods by which a company
raises long-term funds. Funds acquired by issue of debentures represent
loans taken by the company and are also known as ‘debt capital’. A
debenture is a certificate issued by a company under its seal
acknowledging a debt due by it to its holders.
 SOURCES OF LONG-TERM FINANCING
4. Loans from Financial Institutions / Term Loans
5. Retained Earnings - These are the profits that the company has kept
aside over time to meet the company’s future capital needs.

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