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Corporate Finance

Seminar 4: M&A Valuation


Dr George Alexandridis

Suppose a bidder is considering the potential purchase of a target firm and you are asked to
assess whether the target would be a good investment. Provide answers to the following
important questions that arise in applying our fundamental concepts:

1. What are the potential sources of value from the combination? Does the acquirer have

2.
3.
4.
5.

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?
If one performs a stand-alone analysis of the target, what is the proper discount rate to
use?
How does one incorporate the value of synergies in a DCF analysis?
What is the appropriate discount rate to value the merger cash flows?
After determining the enterprise value, how is the value of the equity computed?

Suppose Geo plc has learned that InfoSec plc (a firm in a different industry but in a business
that is strategically attractive to Geo plc) has retained an investment bank to auction the
company and all of its assets. In considering how much to bid for InfoSec, Geo starts with a
cash-flow forecast of the stand-alone business drawn up by InfoSec investment bankers. The
inputs to WACC are shown in Exhibit 1.

1. Calculate the appropriate discount rate to value the cash flows of InfoSec plc
2. Assume that Geo plc will allow InfoSec to run as a stand-alone unit with no synergies. Fill
in the white cells in Exhibit 2, given the additional information provided, to determine
InfoSecs enterprise value.
3. Now suppose Geo plc believes that it can make InfoSecs operations more efficient and
improve its marketing and distribution capabilities. As a result, growth in revenue for
InfoSec plc increases by 2% (for the next 5 years), the COGS/Sales ratio decreases by
2% and the SG&A/Sales ratio decreases by 1% point. Assume that all of the merger
synergies will be realised immediately and so fall well within the 5-year forecast period.
Calculate the value with synergies. Given that the average premium offered for listed
targets in InfoSecs industry is 25%, is this acquisition still worth pursuing?
4. Suppose, as shown in Exhibit 4, there are three publicly traded businesses that are in the
same industry as InfoSec. The respective financial and market data that apply to these
companies are shown in the exhibit. Calculate a multiple-based terminal value estimate
for InfoSec plc assuming that the latter has entered a mature stage of growth. Explain
why multiples may produce spurious estimates?

Exhibit 1. Inputs to WACC.

Bond Rating
Yield To Maturity of Bonds KD

GEO plc

InfoSec Plc

BBB

6.80%

7.01%

Tax Rate

39%

39%

Beta

1.01

1.21

Debt as % of Capital WD

19%

23%

10 Year Treasury Bond Yield

5.78%

5.78%

Market Risk Premium

6.20%

6.20%

Exhibit 2 Valuation of InfoSec plc as Stand-Alone Unit.


Revenue Growth = 6%
Cost of Goods Sold (COGS) / Sales = 54%
Selling, General and Administrative Expenses (SG&A) / Sales = 21%
Net Working Capital (NWC) / Sales = 23%
Steady State Growth = Long-Term Risk Free Rate
Tax = 39%
(all Figures in 000s)
Year 0
Revenues (Sales)

Year 1

Year 2

Year 3

Year 4

Year 5

Steady
State

9,740

COGS
Gross Profit
SG&A
Depreciation
EBIT
-Taxes
NOPAT
(Net Operating Profit After Tax)

Add: Depreciation

1,000

1,000

1,000

1,000

1,000

1,000

Less:Capital Expenditures

1,250

1,250

1,250

1,250

1,250

1,250

10,000

10,250

Less: Increase in NWC


FCF

NWC (23% Sales)


Fixed Assets (FA)
Change in FA
NOPAT/ Sales

(= Year 5)

Terminal Value (TV)


PV (TV)
PV (FCFYear1 to Year5)
Enterprise Value
SalesSteady State = SalesYear 5 (1 + gSteady State)
NOPATSteady State = SalesSteady State (NOPAT/SalesYear 5)
FA1 = FA0 +CAPEX1 Depreciation1 = 10,000+1,250-1,000= 10,250
FASteady State = FA5 + CAPEXSteady State DepreciationSteady State WITH CAPEX = Depreciation in Steady State.
Terminal Value = FCF

Steady State

(WACC g

Steady State

Exhibit 4 Comparable Companies to InfoSec plc.

LVS plc

Xeon plc

Industry X

Industry X

Industry X

Mature

Mature

High Growth

EBIT

3,450

2,700

800

Net Earnings

1,600

1,600

200

Equity Value

14,000

11,400

3,000

Debt Value (Book)

2,800

3,000

3,500

Enterprise Value

16,800

14,400

6,500

Industry
Stage of Growth

Nipta plc

(Share Price x Num. of Shares)

Enterprise Value / EBIT


Equity Value / Net Earnings