# METHODS OF VALUATION FOR MERGERS AND ACQUISITIONS

Size: px
Start display at page:

## Transcription

2 -2- Review of basics of DCF Let s briefly review the construction of free cash flows, terminal value, and the WACC. It is important to realize that these fundamental concepts work equally well when valuing an investment project as they do in an M&A setting. Free cash flows The free cash flows in an M&A analysis should be the operating cash flows attributable to the acquisition, before consideration of financing charges (i.e., pre-financing cash flows). Free cash flow equals the sum of after-tax earnings, plus depreciation and non-cash charges, less capital investment and less investment in working capital. From an enterprise valuation standpoint, earnings must be the earnings after taxes available to all providers of capital or NOPAT (net operating profits after taxes.) The expression for free cash flow is: Free Cash Flow = EBIT (1- T) + Depreciation CAPEX - NWC, where: EBIT is earnings before interest and taxes. T is the marginal cash (not average) tax rate, which should be inclusive of federal, state and local, and foreign jurisdictional taxes. Depreciation is noncash operating charges including depreciation, depletion, and amortization recognized for tax purposes. CAPEX is capital expenditures for fixed assets. NWC is the change in net working capital. 2 Terminal value A terminal value in the final year of the forecast period is added to reflect the present value of all cash flows occurring thereafter. Since it capitalizes the long-term growth prospects of the firm, terminal value is a large component of the value of a company, and therefore careful attention should be paid to it. 2 We assume in this formulation that working capital is increasing and therefore represents a negative cash flow. If net working capital is decreased, however, it enters as a positive component of free cash flow.

3 -3- A standard estimator of the terminal value in period t is the constant growth valuation formula. Terminal Value t FCFt (1+ g) =, where: (WACC g) FCF is the expected free cash flow to all providers of capital in period t. WACC is the weighted average cost of capital. g is the expected constant growth rate in perpetuity per period. Small changes in the growth rate will produce relatively large changes in terminal value, which reminds us that special care should be taken in estimating the growth rate, especially for highgrowth companies. The growth rate cannot exceed WACC in perpetuity. Therefore, cash flows should be projected out to the point where the firm and its industry are in a long-term sustainable equilibrium. This is past the high-growth stage. Every company reaches a mature stage where long-term growth is moderate. At this point the constant growth rate formula becomes applicable and g is likely to take on a value close to the inflation rate plus or minus some small adjustment for other factors (e.g., real growth). Discount rate The discount rate should reflect investors opportunity cost on comparable investments. The WACC must reflect the capital costs that investors would demand in owning assets of similar business risk to the assets being valued. In addition, because the WACC also imbeds an assumption about the target mix of debt and equity, it also must incorporate the appropriate target weights of financing going forward. Recall that the appropriate rate is a blend of the required rates of return on debt and equity, weighted by the proportion these capital sources make up of the firm s market value. WACC = W d k d (1-T) + W e k e, where: k d is the interest rate on new debt. k e is the cost of equity capital (see below). W d, W e are target percentages of debt and equity (using market values of debt and equity.) 3 T is the marginal tax rate. The costs of debt and equity should be going-forward market rates of return. For debt securities, this is often the yield to maturity that would be demanded on new instruments of the 3 Debt for purposes of the WACC should include all permanent, interest bearing debt. If the market value of debt is not available, the book value of debt is often assumed as a reasonable proxy. The approximation is more accurate the shorter the maturity of the debt and the closer the correspondence between the coupon rate and required return on the debt.

4 -4- same credit rating and maturity. The cost of equity can be obtained from the Capital Asset Pricing Model (CAPM). k e = R f + ß (R m - R f ), where: R f is the expected return on risk-free securities over a time horizon consistent with the investment horizon. Generally use the ten-year government bond rate. R m - R f is the historic risk premium for common stocks over government bonds (6.0 percent.) ß is beta, a measure of the systematic risk of a firm s common stock. The beta of common stock includes compensation for business and financial risk. The M&A setting No doubt many of these concepts look familiar so that we must now consider how they are altered by the evaluation of a company in an M&A setting. First, we should recognize that there are two parties (sometimes more) in the transaction: an acquirer (buyer, or bidder) and a target firm (seller, or acquired.) Suppose a bidder is considering the potential purchase of a target firm and we are asked to assess whether the target would be a good investment. There are some important questions that arise in applying our fundamental concepts: 1. What are the potential sources of value from the combination? Does the acquirer have particular skills, or capabilities that can be used to enhance the value of the target firm? Does the target have critical technology, or other strengths that can bring value to the acquirer? Potential sources of gain or cost savings achieved through the combination are called synergies. Baseline cash flow projections for the target firm may or may not include synergies, or cost savings gained from merging the operations of the target into those of the acquirer. If the base-case cash flows do not include any of the economic benefits an acquirer might bring to a target, they are referred to as stand-alone cash flows. Examining the value of a target on a stand-alone basis can be valuable for several reasons. First, it can provide a view of what the target firm is capable of achieving on its own. This may help establish a floor with respect to value for negotiating purposes. Second, construction of a stand-alone DCF valuation can be compared to the target s current market value. This can be useful in assessing whether the target is under or over valued in the market place. However, given the general efficiency of markets, it is unlikely that a target will be significantly over or under valued relative to the market. Hence, a stand-alone DCF valuation allows analysts to calibrate model assumptions to those of investors. By testing key assumptions relative to this important benchmark, analysts can gain confidence that the model provides a reasonable guide to investors perception of the situation.

5 -5-2. If one performs a stand-alone analysis of the target, what is the proper discount rate to use? If the target is going to be run autonomously on a stand-alone basis, the most appropriate cost of capital is the WACC of the target firm. In this instance, the business risk investors bear as a result of this transaction is the risk of the target s cash flows. The use of the target s WACC also assumes that the target firm is financed with the optimal proportions of debt and equity and that these proportions will continue post-merger. Less frequently, an acquirer may intend to increase or decrease the debt level of the target significantly after the merger perhaps because it believes the target s current financing mix is not optimal. The WACC still must reflect the business risk of the target. A proxy for this can be obtained from the unlevered beta of the target firm s equity. However, in this circumstance, the target s pre-merger unlevered beta must be relevered to reflect the acquirer s intended post-merger capital structure. Step 1: Unlever the beta ß u = ß L /[1 + (1-T) D/E], where D/E is the target s debt-equity ratio before acquisition. ß u is the target s unlevered beta: ß L is the target s pre-merger beta. Step 2: Relever the beta ß ' L * = ß [1+ (1 T)D/E ], where u D/E * is the intended debt-equity ratio after relevering. ß ' L is the post-merger target beta. 3. How does one incorporate the value of synergies in a DCF analysis? Operating synergies are reflected in enterprise value by altering the stand-alone cash flows to incorporate the benefits and costs of the combination. Free cash flows that include the value an acquirer and target can achieve through combination and are referred to as combined or merger cash flows. If the acquirer plans to run the acquired company as a stand-alone entity, as in the case of Berkshire Hathaway purchasing a company unrelated to its existing holdings, there may be little difference between the stand-alone and merger cash flows. However, in many strategic acquisitions, such as the Vodafone-Mannesman, AOL-Time-Warner, there can be sizeable differences. Moreover, how the value of these synergies is split between the parties through the determination of the final bid price or premium paid is a major

7 -7- equity ratio of the target industry. Note that this procedure usually produces similar results to averaging the WACCs of the target industry firms. 5 The circumstances of each transaction will dictate which of these approaches is most reasonable. Of course, if the target s business risk somehow changes as a result of the merger, some adjustments must be made to all of these approaches on a judgment basis. The key concept is to find the WACC that best reflects the business and financial risks of the target s cash flows. Example of DCF Method Suppose A-Company has learned that its competitor, B-Company, has retained an investment bank to auction the company and all of its assets. In considering how much to bid for B-Co., A-Co. starts with the projected cash flow statement drawn up by B-Co. s investment bankers shown below. If a competitor or A-Co. were to acquire B-Co. and allow it to run as an autonomous, or stand-alone unit it would also make sense to use B-Co. s weighted average cost of capital of 10.94% to value the company. The inputs to WACC will be discussed further later. On a stand-alone basis, the analysis suggests that B-Co. s enterprise value is \$13.7 million. Cash Flows of B-Company with No Synergies (Assume that A-Company or other acquirer allows former B-Company to run as a stand-alone unit.) Revenue Growth 3% Terminal Value Growth 3% COGS 55% WACC 10.94% SG&A 20% Tax rate 39% NWC 22% Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Revenues (\$ thousands) 9,750 10,000 10,300 10,609 10,927 11,255 COGS 5,500 5,665 5,835 6,010 6,190 Gross Profit 4,500 4,635 4,774 4,917 5,065 SG&A 2,000 2,060 2,122 2,185 2,251 Depreciation 1,000 1,000 1,000 1,000 1,000 Operating Profit-pre-tax 1,500 1,575 1,652 1,732 1,814 Taxes NOPAT ,008 1,056 1,106 Add: Depreciation 1,000 1,000 1,000 1,000 1,000 5 We generally prefer method b to method c. The inputs for estimating WACC correspond to observable market parameters that relate to how investors perceive the firm e.g., bond rating (how much debt is used?), current yields to maturity, and beta. These inputs lead to estimates that are more consistent with investors perceptions of the firm and risks.

8 -8- Less: Capital Expenditures (800) (800) (800) (800) (800) Less: Increase in NWC (55) (66) (68) (70) (72) Free Cash Flow 1,060 1,095 1,140 1,186 1,234 Valuation of B-Company with No Synergies Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Free Cash Flow 1,060 1,095 1,140 1,186 1,234 Terminal Value 16,008 Total Cash Flows 1,060 1,095 1,140 1,186 17,243 Enterprise Value = PV 10.94% (FCF) =13,723 Now suppose A-Co. believes that it can make B-Co. s operations more efficient and improve its marketing and distribution capabilities. We can incorporate these effects into the cash flow model, and thereby estimate a higher range of values that A-Co. can bid and still realize a positive net present value (NPV) for A-Co. s shareholders. In the combined cash flow model of the two firms below, A+B-Co. has added two percentage points to revenue growth and subtracted one percentage point from both the COGS/Sales and SG&A/Sales ratios relative to the stand-alone model. We assume that all of the merger synergies will be realized within the first five years of combined operations and thus fall within the forecast period. Because A and B are in the same industry, it is assumed that the business risk of B-Co. s post-merger operations are similar to A-Co. s. Because the two entities have the same business risk and A-Co. is the purchaser and surviving entity, we can use A-Co. s WACC of 10.62% in the valuation. Notice that the value with synergies, \$14.6 million, exceeds the value as a stand-alone entity by approximately one million dollars. In devising its bidding strategy, A-Co. would not want to offer \$14.6 million and concede all of the value of the synergies to B-Co. At this price, the NPV of the acquisition to A-Co. is zero. However, the existence of synergies allows A-Co. leeway to increase its bid above \$13.7 million and enhance its chances of winning the auction. Combined Cash Flows of A+B-Co. with Synergies (Assume that former B-Co. operations are merged with A-Co. and have the same business risk.) Revenue Growth 5% Terminal Value Growth 3% COGS 54% WACC 10.62% SG&A 19% Taxes 39% NWC 22% Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

9 -9- Revenues (\$thousands) 9,750 10,000 10,500 11,025 11,576 12,155 COGS 5,400 5,670 5,954 6,251 6,564 Gross Profit 4,600 4,830 5,072 5,325 5,591 SG&A 1,900 1,995 2,095 2,199 2,309 Depreciation 1,050 1,050 1,050 1,050 1,050 Operating Profit-pre-tax 1,650 1,785 1,927 2,076 2,232 Taxes NOPAT 1,007 1,089 1,175 1,266 1,361 Add: Depreciation 1,050 1,050 1,050 1,050 1,050 Less: Capital Expenditures (1,000) (1,000) (1,000) (1,000) (1,000) Less: Increase in NWC (55) (110) (116) (121) (127) Free Cash Flow 1,002 1,029 1,110 1,195 1,284 Valuation of A+B-Co. with Synergies Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Free Cash Flow 1,002 1,029 1,110 1,195 1,284 Terminal Value 17,357 Total Cash Flows 1,002 1,029 1,110 1,195 18,641 Enterprise Value = PV 10.62% (FCF) =14,618 The inputs to the target s and acquirer s WACCs are summarized below. Note that because A and B are in the same industry, their betas and bond ratings, while not exact, are similar. The use of either WACC would allow the bidder to offer more than \$13.7 million and move forward with the offer. Had the target been in a different industry than the acquirer, one is less likely to observe a similarity in WACCs between the target and acquirer. In this case, one is better advised to focus on where the money is going, rather than where the money comes from in determining the risk associated with the transaction. In other words, the analysts should focus on the target s risk and financing in determining the appropriate discount rate. A-Co. B-Co. Bond Rating A BBB Interest Rate on Bonds 7.20% 7.42% Tax Rate 39% 39% After-tax Cost of debt 4.39% 4.53% Beta Cost of equity -Ke 12.18% 13.08% Debt % of Capital 20% 25% Equity % of Capital 80% 75%

10 year Treasury Bond 5.88% 5.88% Equity Risk Premium 6.00% 6.00% WACC 10.62% 10.94% Other Valuation Methods Although we have focused on the DCF method, other methods provide useful complementary information in assessing the value of a target. We briefly review some of the most popularly used techniques. Book value May be appropriate for firms with no intangible assets, commodity-type assets valued at market, and stable operations. Some caveats: This method depends on accounting practices that vary across firms. Ignores intangible assets like brand names, patents, technical know-how, managerial competence. Ignores price appreciation due, for instance, to inflation. Invites disputes about types of liabilities. For instance, are deferred taxes equity or debt? Book value method is backward looking. It ignores the positive or negative operating prospects of the firm. Liquidation value The sale of assets at a point in time. May be appropriate for firms in financial distress, or more generally, for firms whose operating prospects are very cloudy. Requires the skills of a business mortician rather than an operating manager. Some caveats: Difficult to get a consensus valuation. Liquidation values tend to be highly appraiser-specific.

11 -11- Key judgment: How finely one might break up the company: Group? Division? Product line? Region? Plant? Machines? Physical condition, not age, will affect values. There can be no substitute for an on-site assessment of a company s real assets. May ignore valuable intangible assets. Replacement-cost value In the 1970s and early 1980s, during the era of high inflation in the United States, the Securities and Exchange Commission required public corporations to estimate replacement values in their 10-K reports. This is no longer the case making this method less useful for U.S. firms, but still is useful for international firms where the requirement continues. Often cited to explain the merger wave of 1970s and early 1980s. Since stock market values tended to be less than replacement cost, buyers seemed to be realizing bargain prices. It s cheaper to buy than build. This seems unlikely to be an explanation for the merger boom of the 1990s. But comparisons of replacement costs and stock market values ignore the possible reasons for the disparity: overcapacity, high interest rates, oil shocks, inflation, etc. Replacement cost estimates not highly reliable, often drawn by simplistic rules of thumb. Estimators themselves (operating managers) frequently dismiss the estimates. Stock-market value (stock price shares outstanding) Helpful if the stock is actively traded, followed by professional securities analysts, and if the market efficiently impounds all public information about the company and its industry. Rarely do merger negotiations settle at a price below the market price of the target. On average, mergers and tender offers command a 30-50% premium over the price one day before the merger announcement. Premiums have been observed to be as high as100% in some instances. Often the price increase is attributed to a control premium. The premium will depend on: i. the rarity of the assets sought after and to what extent there are close substitutes for the technology, expertise, or capability in question, ii. the distribution of financial resources between the bidder and target, iii. the egos of the CEOs involved (the hubris hypothesis), or iv. the possibility that the ex ante target price was unduly inflated by market rumors.

12 -12- Less helpful for less well-known companies with thinly or intermittently traded stock. Not available for privately-held companies. Ignores private information known only to insiders or acquirers who may see a special economic opportunity in the target company. Remember, the market can efficiently impound only public information. Trading multiples of peer firms Most frequently observed are price-earnings ratios and market value of equity to book value of equity ratios. If a multiple is used in place of the constant growth model for terminal value, the multiple must be based on cash flow, EBIT, or EBITDA (i.e., not Price-Earnings ratio). Only these multiples are consistent with the definition of free cash flow as prefinancing cash flows available to all capital. Requires a forecast of EBIT or earnings for the next year. Never use last year s EBIT or earnings; the market only capitalizes future performance. Some caveats: Requires careful research to find other firms comparable to the target company. Depends on accounting practices. There are a number of acceptable ways to determine operating earnings. Assumes the same (but undefined) growth rate in perpetuity. Can ignore the critical differences between profits and cash flow: e.g., new capital expenditures and investment in net working capital, and depreciation. May not separate the investment and financing effects into discrete variables. Difficult to analyze the effect of financing changes. May ignore the time value of money. Transaction multiples for comparable deals In an M&A setting, analysts will look to comparable transactions as an additional benchmark against which to assess the target firm. The chief difference between transaction multiples and peer multiples is that the former will reflect a control premium, typically 30 to 50 percent, that is not present in the ordinary trading multiples. If one is examining the price

14 -14- Virtually every number used in valuation is measured with error, either because of flawed methods to describe the past or because of uncertainty about the future. Therefore, No valuation is right in any absolute sense. It is appropriate to use several scenarios about the future, and even several valuation methods to bound the target s value. Adapt to diversity. It may be easier and more accurate to value the divisions or product lines of a target, than to value the whole company. Recognize that different valuation methods may be appropriate for different components. Avoid analysis paralysis. Bound the value quickly, then if the target still looks attractive try some sensitivity analysis. Beyond the initial buy/no buy decision, the purpose of most valuation analysis is to support negotiators. Knowing value boundaries and conducting sensitivity analysis enhances one s flexibility to respond to new ideas that may appear at the negotiating table.

### METHODS OF VALUATION FOR MERGERS AND ACQUISITIONS

METHODS OF VALUATION FOR MERGERS AND ACQUISITIONS This note addresses the methods used to value companies in a merger and acquisitions (M&A) setting. It provides a detailed description of the discounted-cash-flow

### USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE

Graduate School of Business Administration - University of Virginia USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE Planned changes in capital structure over time increase the complexity of

### CHAPTER 14 COST OF CAPITAL

CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,

### Practice Bulletin No. 2

Practice Bulletin No. 2 INTERNATIONAL GLOSSARY OF BUSINESS VALUATION TERMS To enhance and sustain the quality of business valuations for the benefit of the profession and its clientele, the below identified

### International Glossary of Business Valuation Terms*

40 Statement on Standards for Valuation Services No. 1 APPENDIX B International Glossary of Business Valuation Terms* To enhance and sustain the quality of business valuations for the benefit of the profession

### INTERVIEWS - FINANCIAL MODELING

420 W. 118th Street, Room 420 New York, NY 10027 P: 212-854-4613 F: 212-854-6190 www.sipa.columbia.edu/ocs INTERVIEWS - FINANCIAL MODELING Basic valuation concepts are among the most popular technical

### Fundamentals Level Skills Module, Paper F9

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2008 Answers 1 (a) Calculation of weighted average cost of capital (WACC) Cost of equity Cost of equity using capital asset

### VALUATIONS I Financial Metrics, Ratios, & Comparables Analysis. Fall 2015 Comp Week 6

VALUATIONS I Financial Metrics, Ratios, & Comparables Analysis Fall 2015 Comp Week 6 CODE: COMPS Timeline Date Topic 9/10/15 Introduction to Finance 9/17/15 Qualitative Analysis: SWOT and Porter s Five

### Equity Analysis and Capital Structure. A New Venture s Perspective

Equity Analysis and Capital Structure A New Venture s Perspective 1 Venture s Capital Structure ASSETS Short- term Assets Cash A/R Inventories Long- term Assets Plant and Equipment Intellectual Property

### CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.

### CIMA F3 Course Notes. Chapter 11. Company valuations

CIMA F3 Course Notes Chapter 11 Company valuations Personal use only - not licensed for use on courses 144 1. Company valuations There are several methods of valuing the equity of a company. The simplest

### Valuation for merger and acquisition. March 2015

Valuation for merger and acquisition March 2015 Flow of presentation Valuation methodologies Valuation in the context of Merger and Acquisition Indian Regulatory Environment and Minority Interest Safeguard

Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A-1 Appendix 17A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition

### The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction

Chapter 18 Valuation and Capital Budgeting for the Levered Firm 18A-1 Appendix 18A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition

### FSA Note: Summary of Financial Ratio Calculations

FSA Note: Summary of Financial Ratio Calculations This note contains a summary of the more common financial statement ratios. A few points should be noted: Calculations vary in practice; consistency and

Valuing the Business 1. Introduction After deciding to buy or sell a business, the subject of "how much" becomes important. Determining the value of a business is one of the most difficult aspects of any

### Valuation approaches to Mergers & Acquisitions

Valuation approaches to Mergers & Acquisitions Sagar Gokani, Chief Manager M&A & IR, Piramal Healthcare Limited 7 th July 2012 Contents Approaches to Valuation Discounted Cash Flow Relative Valuation Valuing

### Forecasting and Valuation of Enterprise Cash Flows 1. Dan Gode and James Ohlson

Forecasting and Valuation of Enterprise Cash Flows 1 1. Overview FORECASTING AND VALUATION OF ENTERPRISE CASH FLOWS Dan Gode and James Ohlson A decision to invest in a stock proceeds in two major steps

### Cost of Capital and Project Valuation

Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different

### A Primer on Valuing Common Stock per IRS 409A and the Impact of Topic 820 (Formerly FAS 157)

A Primer on Valuing Common Stock per IRS 409A and the Impact of Topic 820 (Formerly FAS 157) By Stanley Jay Feldman, Ph.D. Chairman and Chief Valuation Officer Axiom Valuation Solutions May 2010 201 Edgewater

### Using the FRR to rate Project Business Success

Using the FRR to rate Project Business Success The purpose of this note is to explain the calculation of the financial rate of return (FRR), with a view, firstly to clarify the FRR concept and its determination,

IE Aufgabe 4 The Adjusted-Present-Value Approach to Valuing Leveraged Buyouts 1) Introduction A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company

### A Piece of the Pie: Alternative Approaches to Allocating Value

A Piece of the Pie: Alternative Approaches to Allocating Value Cory Thompson, CFA, CIRA cthompson@srr.com Ryan Gandre, CFA rgandre@srr.com Introduction Enterprise value ( EV ) represents the sum of debt

### Acquisition Valuation

Acquisition Valuation Aswath Damodaran Aswath Damodaran 1 Issues in Acquisition Valuation Acquisition valuations are complex, because the valuation often involved issues like synergy and control, which

### Cash Flow Analysis Venture Business Perspective

Cash Flow Analysis Venture Business Perspective Cash Flow (CF) Analysis What is CF and how is determined? CF Free CF Managing CF Cash Conversion Cyclical CF Break-even Valuing venture businesses based

### I m going to cover 7 key points about FCF here:

Free Cash Flow Overview When you re valuing a company with a DCF analysis, you need to calculate their Free Cash Flow (FCF) to figure out what they re worth. While Free Cash Flow is simple in theory, in

### NOTICE: For details of the project history please look under the Work Plan section of this website.

NOTICE: This Exposure Draft is available to show the historic evolution of the project. It does not include changes made by the Board following the consultation process and therefore should not be relied

### Financial Condition Analysis Model

Financial Condition Analysis Model GOVERNMENTAL ACTIVITIES & ENTERPRISE FUNDS Economic resources and accrual basis of accounting Flow Financial Dimension Financial Indicator Interpretation Interperiod

### BA 351 CORPORATE FINANCE. John R. Graham Adapted from S. Viswanathan LECTURE 10 THE ADJUSTED NET PRESENT VALUE METHOD

BA 351 CORPORATE FINANCE John R. Graham Adapted from S. Viswanathan LECTURE 10 THE ADJUSTED NET PRESENT VALUE METHOD FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY 1 THE ADJUSTED NET PRESENT VALUE METHOD COPING

### What is the fair market

3 Construction Company Valuation Primer Fred Shelton, Jr., CPA, MBA, CVA EXECUTIVE SUMMARY This article explores the methods and techniques used in construction company valuation. Using an illustrative

### The cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction

The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal

### CREATING SYNERGY THROUGH MERGER AND ACQUISITION INTEGRATION: AN OVERVIEW

168 CREATING SYNERGY THROUGH MERGER AND ACQUISITION INTEGRATION: AN OVERVIEW SUMANTA DUTTA*; PROF.UTTAM KUMAR DUTTA**; SAJAL DAS*** *Assistant Professor, Department of Business Administration, Dinabandhu

### VALUATION JC PENNEY (NYSE:JCP)

VALUATION JC PENNEY (NYSE:JCP) Prepared for Dr. K.C. Chen California State University, Fresno Prepared by Sicilia Sendjaja Finance 129-Student Investment Funds December 15 th, 2009 California State University,

### CHAPTER 7: NPV AND CAPITAL BUDGETING

CHAPTER 7: NPV AND CAPITAL BUDGETING I. Introduction Assigned problems are 3, 7, 34, 36, and 41. Read Appendix A. The key to analyzing a new project is to think incrementally. We calculate the incremental

### Leveraged Buyout Model Quick Reference

Leveraged Buyout (LBO) Model Overview A leveraged buyout model shows what happens when a private equity firm acquires a company using a combination of equity (cash) and debt, and then sells it in 3-5 years.

Overview of Business Valuations By CA Niketa Agarwal Last few years have not been encouraging for the global economy due to crisis and slow recovery in several large and developed countries. India experienced

### ISSUES ON USING THE DISCOUNTED CASH FLOWS METHODS FOR ASSET VALUATION

ISSUES ON USING THE DISCOUNTED CASH FLOWS METHODS FOR ASSET VALUATION CRISTINA AURORA BUNEA-BONTAŞ 1, MIHAELA COSMINA PETRE 2 CONSTANTIN BRANCOVEANU UNIVERSITY OF PITESTI, FACULTY OF MANAGEMENT-MARKETING

### GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE

GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 2010-2011 Chapter 18 Capital Budgeting and Valuation with Leverage

### Fundamentals Level Skills Module, Paper F9

Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2008 Answers 1 (a) Rights issue price = 2 5 x 0 8 = \$2 00 per share Theoretical ex rights price = ((2 50 x 4) + (1 x 2 00)/5=\$2

### Contribution 787 1,368 1,813 983. Taxable cash flow 682 1,253 1,688 858 Tax liabilities (205) (376) (506) (257)

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2012 Answers 1 (a) Calculation of net present value (NPV) As nominal after-tax cash flows are to be discounted, the nominal

### Leverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview

Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for

### LOS 42.a: Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity (FCFE).

The following is a review of the Equity Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Free Cash Flow Valuation This

### Paper F9. Financial Management. Fundamentals Pilot Paper Skills module. The Association of Chartered Certified Accountants

Fundamentals Pilot Paper Skills module Financial Management Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FOUR questions are compulsory and MUST be attempted. Do NOT open this paper

### TIP If you do not understand something,

Valuing common stocks Application of the DCF approach TIP If you do not understand something, ask me! The plan of the lecture Review what we have accomplished in the last lecture Some terms about stocks

### t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

### ( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100

Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded

### Valuation for Mergers, Buyouts and Restructuring (John Wiley & Sons, New York, 2005)

Valuation for Mergers, Buyouts and Restructuring (John Wiley & Sons, New York, 2005) Professor of Finance and Economics Graduate School of Business, Columbia University New York, N.Y. 10027 Email: era1@columbia.edu

### Econ Pro Valuation Methods - General recap and pitfalls. October 1, 2010

Econ Pro Valuation Methods - General recap and pitfalls October 1, 2010 1 Agenda Valuation Dimensions & Applications Valuation Methods Market method Cost method Income method Income method for Intangible

### MBA (3rd Sem) 2013-14 MBA/29/FM-302/T/ODD/13-14

Full Marks : 70 MBA/29/FM-302/T/ODD/13-14 2013-14 MBA (3rd Sem) Paper Name : Corporate Finance Paper Code : FM-302 Time : 3 Hours The figures in the right-hand margin indicate marks. Candidates are required

### VALUATION CA Bhavik Shah 16 May 2015

VALUATION CA Bhavik Shah 16 May 2015 Presentation Overview Valuation Concept Purpose of Valuation Principal Methods of Valuation Net Assets Value (NAV) Method Price to Book Multiple (P/B) Method Price

### Chapter 4: Liquor Store Business Valuation

Chapter 4: Liquor Store Business Valuation In this section, we will utilize three approaches to valuing a liquor store. These approaches are the: (1) cost (asset based), (2) market, and (3) income approach.

### ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure

ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for \$40/share. Your analysis of the company

### Corporate Finance: Final Exam

Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate

### What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated?

What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? HOCK international - 2004 1 HOCK international - 2004 2 How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? HOCK

### Today s Agenda. DFR1 and Quiz 3 recap. Net Capital Expenditures. Working Capital. Dividends. Estimating Cash Flows

Today s Agenda DFR1 and Quiz 3 recap Net Capital Expenditures Working Capital Dividends Estimating Cash Flows Net Capital expenditures Net capital expenditures = capital expenditures - depreciation Depreciation

### 1 (a) Net present value of investment in new machinery Year 1 2 3 4 5 \$000 \$000 \$000 \$000 \$000 Sales income 6,084 6,327 6,580 6,844

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2013 Answers 1 (a) Net present value of investment in new machinery Year 1 2 3 4 5 \$000 \$000 \$000 \$000 \$000 Sales income 6,084

### FUNDAMENTALS OF HEALTHCARE FINANCE. Online Appendix B Financial Analysis Ratios

3/27/09 FUNDAMENTALS OF HEALTHCARE FINANCE Online Appendix B Financial Analysis Ratios Introduction In Chapter 13 of Fundamentals of Healthcare Finance, we indicated that financial ratio analysis is a

### for Analysing Listed Private Equity Companies

8 Steps for Analysing Listed Private Equity Companies Important Notice This document is for information only and does not constitute a recommendation or solicitation to subscribe or purchase any products.

### CFAspace. CFA Level II. Provided by APF. Academy of Professional Finance 专 业 金 融 学 院

CFAspace Provided by APF CFA Level II Equity Investments Free Cash Flow Valuation Part I CFA Lecturer: Hillary Wang Content Free cash flow to the firm, free cash flow to equity Ownership perspective implicit

### PIPEs: Private Equity Investments in Distressed Firms

UVA -F-1412 PIPEs: Private Equity Investments in Distressed Firms Direct investment in the equity of distressed companies by private equity investors is a relatively recent phenomenon dating to the mid-1990s.

### CHAPTER 8. Problems and Questions

CHAPTER 8 Problems and Questions 1. Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): Assets Liabilities

### HEALTHCARE FINANCE: AN INTRODUCTION TO ACCOUNTING AND FINANCIAL MANAGEMENT. Online Appendix A Financial Ratios

HEALTHCARE FINANCE: AN INTRODUCTION TO ACCOUNTING AND FINANCIAL MANAGEMENT Online Appendix A Financial Ratios INTRODUCTION In Chapter 17, we indicated that ratio analysis is a technique commonly used to

### Cash flow before tax 1,587 1,915 1,442 2,027 Tax at 28% (444) (536) (404) (568)

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2014 Answers 1 (a) Calculation of NPV Year 1 2 3 4 5 \$000 \$000 \$000 \$000 \$000 Sales income 5,670 6,808 5,788 6,928 Variable

### Midland Energy/Sample 2. Midland Energy Resources, Inc.

Midland Energy Resources, Inc. Midland Energy Resources, Inc. is a global energy company that operates in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals.

### DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax

### Appendix B Weighted Average Cost of Capital

Appendix B Weighted Average Cost of Capital The inclusion of cost of money within cash flow analyses in engineering economics and life-cycle costing is a very important (and in many cases dominate) contributing

### Management Accounting Financial Strategy

PAPER P9 Management Accounting Financial Strategy The Examiner provides a short study guide, for all candidates revising for this paper, to some first principles of finance and financial management Based

### Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management

Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management Final Mock Exam 1 Marking scheme and suggested solutions DO NOT TURN THIS PAGE UNTIL YOU HAVE COMPLETED THE MOCK EXAM ii Financial

### Finance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012. Part One: Multiple-Choice Questions (45 points)

Finance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012 Part One: Multiple-Choice Questions (45 points) Question 1 Assume that capital markets are perfect. Which of the following statements

### REIT valuation. Real estate finance

REIT valuation Real estate finance (a) Basics Basics Real Estate Investment Trusts 1. buy, sell and hold real estate assets on behalf of a diffuse shareholder base 2. manage these and other assets 3. are

### Discounted Cash Flow Methodology. Table of Contents. Section 1 Discounted Cash Flow Overview CONFIDENTIAL. DCF Primer 5467729.doc

Table of Contents Section 1 Discounted Cash Flow Overview CONFIDENTIAL DCF Primer 5467729.doc Section 1 Discounted Cash Flow Overview The DCF approach values a business based on its future expected cash

### TYPES OF FINANCIAL RATIOS

TYPES OF FINANCIAL RATIOS In the previous articles we discussed how to invest in the stock market and unit trusts. When investing in the stock market an investor should have a clear understanding about

### Napoli Pizza wants to determine its optimal capital structure

Napoli Pizza wants to determine its optimal capital structure ABSTRACT Brad Stevenson Daniel Bauer David Collins Keith Richardson This case is based on an actual business decision that was made by a small,

### NORTHWESTERN UNIVERSITY J.L. KELLOGG GRADUATE SCHOOL OF MANAGEMENT

NORTHWESTERN UNIVERSITY J.L. KELLOGG GRADUATE SCHOOL OF MANAGEMENT Tim Thompson Finance D42 Fall, 1997 Teaching Note: Valuation Using the Adjusted Present Value (APV) Method vs. Adjusted Discount Rate

### Valuing Companies. Katharina Lewellen Finance Theory II May 5, 2003

Valuing Companies Katharina Lewellen Finance Theory II May 5, 2003 Valuing companies Familiar valuation methods Discounted Cash Flow Analysis Comparables Real Options Some new issues Do we value assets

### Projecting the 3 Statements & 3-Statement Modeling Quiz Questions

Projecting the 3 Statements & 3-Statement Modeling Quiz Questions 1. Let s say that we re creating 3-statement projections for a company, and in its historical filings Depreciation & Amortization and Stock-Based

### Understanding Financial Information for Bankruptcy Lawyers Understanding Financial Statements

Understanding Financial Information for Bankruptcy Lawyers Understanding Financial Statements In the United States, businesses generally present financial information in the form of financial statements

### Cost of Capital, Valuation and Strategic Financial Decision Making

Cost of Capital, Valuation and Strategic Financial Decision Making By Dr. Valerio Poti, - Examiner in Professional 2 Stage Strategic Corporate Finance The financial crisis that hit financial markets in

### A Primer on Valuing Common Stock per IRS 409A and the Impact of FAS 157

A Primer on Valuing Common Stock per IRS 409A and the Impact of FAS 157 By Stanley Jay Feldman, Ph.D. Chairman and Chief Valuation Officer Axiom Valuation Solutions 201 Edgewater Drive, Suite 255 Wakefield,

### The Match Game: Cap Rates and Cash Flows

The Match Game: Cap Rates and Cash Flows 44 th Annual Wichita Program Appraisal for Ad Valorem Taxation Jay Fletcher Washington Department of Revenue jayf@dor.wa.gov Paul Simon Xcel Energy paul.a.simon@xcelenergy.com

### CHAPTER 8 STOCK VALUATION

CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.

### What's Your Business Worth? What you see isn't usually what you get - or want!

What's Your Business Worth? What you see isn't usually what you get - or want! "How much is my business worth?" and "How do I know for sure?" and "Why should I care? After all, I have no intention of selling

### Chapter 13, ROIC and WACC

Chapter 13, ROIC and WACC Lakehead University Winter 2005 Role of the CFO The Chief Financial Officer (CFO) is involved in the following decisions: Management Decisions Financing Decisions Investment Decisions

### Practice Exam (Solutions)

Practice Exam (Solutions) June 6, 2008 Course: Finance for AEO Length: 2 hours Lecturer: Paul Sengmüller Students are expected to conduct themselves properly during examinations and to obey any instructions

### SELECTING AND ASSESSING A TARGET FIRM FOR AN INTERNATIONAL MERGER OR ACQUISITION

SELECTING AND ASSESSING A TARGET FIRM FOR AN INTERNATIONAL MERGER OR ACQUISITION ELENA NIKOLOVA, Ass. MSc. 1, MARIJA GOGOVA, Ass. MSc. 2, MARGARITA MATLIEVSKA Ass. Prof. PhD. 3, KRSTE SAJNOSKI Ass. Prof.

### Capital budgeting & risk

Capital budgeting & risk A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Measurement of project risk 3. Incorporating risk in the capital budgeting decision 4. Assessment of

FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal year-ended February 1, 2015 (the 2014 fiscal

### CHAPTER 5 HOW TO VALUE STOCKS AND BONDS

CHAPTER 5 HOW TO VALUE STOCKS AND BONDS Answers to Concepts Review and Critical Thinking Questions 1. Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used

### Valuation for Mergers and Acquisitions. Prepared By Ooi Kok Hwa MRR Consulting

Valuation for Mergers and Acquisitions Prepared By Ooi Kok Hwa MRR Consulting Agenda This seminar will explain: Various valuation approaches for M&A exercises; Determine the value of target companies as

Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual

### ] (3.3) ] (1 + r)t (3.4)

Present value = future value after t periods (3.1) (1 + r) t PV of perpetuity = C = cash payment (3.2) r interest rate Present value of t-year annuity = C [ 1 1 ] (3.3) r r(1 + r) t Future value of annuity

### DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2.

DUK UNIRSITY Fuqua School of Business FINANC 351 - CORPORAT FINANC Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%. Consider a firm that earns \$1,000

### Buying & Selling BUSINESS VALUATION. De-mystifying Risk and the Earnings Multiple For Both Buyers and Sellers. By Dexter W. Braff

Buying & Selling BUSINESS VALUATION De-mystifying Risk and the Earnings Multiple For Both Buyers and Sellers By Dexter W. Braff Buyers are buying. Sellers are selling. Millions of dollars are riding on

### Use the table for the questions 18 and 19 below.

Use the table for the questions 18 and 19 below. The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price

### Impairment Testing Procedures and Pitfalls

Audio Conference Dial-in Number: 877.691.9300; Access Code: 4321206 Impairment Testing Procedures and Pitfalls November 3, 2009 Presenters: Cory J. Thompson, CFA, CIRA Ryan A. Gandre, CFA Moderator: Jay