Mergers and Acquisitions Valuation

This assignment delves into the complexities of valuing mergers and acquisitions (M&A). It explores key concepts such as the Weighted Average Cost of Capital (WACC) and Discounted Cash Flow (DCF) analysis. Students will analyze case studies, calculate terminal values, and determine the value of operations and equity in an M&A scenario. The assignment also highlights the limitations of common valuation methods and emphasizes the importance of subjective estimations in projecting future cash flows.

MANAGING FINANCIAL RESOURCES

TABLE OF CONTENTS
QUESTION 1..................................................................................................................................1
QUESTION 2..................................................................................................................................1
QUESTION 3..................................................................................................................................1
QUESTION 4..................................................................................................................................2
QUESTION 5..................................................................................................................................2
QUESTION 6..................................................................................................................................2
QUESTION 7..................................................................................................................................2
QUESTION 8..................................................................................................................................3
QUESTION 9..................................................................................................................................3
QUESTION 10................................................................................................................................3
REFERENCES................................................................................................................................4

QUESTION 1
WACC represent the required rate of return for the capital projects that lasts for long-
term year hence, it represent the average risk. However, merger and acquisition is not a average
kind of project, therefore, it requires a different rate of return that incorporates higher risk rate to
compute the value (Frank and Shen, 2016).
QUESTION 2
Different acquirers compute different value for acquisition because of different methods
used including liquidation value, real estate value, book value and enterprise value. Liquidation
value indicates the amount that will be paid if all the assets and liabilities are settled off. On the
other side, company which has a significant real estate holding can use real estate value as a
primary basis for valuation. Book value measures the amount if assets and liabilities are sold off
at value appears in accounting books. Enterprise value indicates the amount when acquirer needs
to buy shares in open market, pay-off debt, and keep remaining cash balance on the target
company’s balance sheet (Acquisition valuation methods, 2017). Thus, as different entities use
different valuation method therefore, acquisition value differs from each other.
Besides this, there are different methods such price-earning ratio, DCF method, dividend
growth method and others. Moreover, acquirer may use DCF and rate of return for valuation. In
addition, the projected cash flow varies from acquirer to acquirer based on their future plans
(Brooks, 2015). Another aspect is cost of equity & debt may also vary which product different
valuation.
QUESTION 3
Calculation of cost of unlevered equity
= ke*Proportion of equity + kd*cost of
= (0.50*0.20) + (0.50*0.07)
= 0.10 + 0.035
= 0.135 OR 13.5%
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QUESTION 4
Weighted average cost of capital
= ke*Proportion of equity + kd*cost of debt *(1-tax rate)
= (0.20*0.50) + (0.50*0.07(1-0.40)
= 10% + 2.10%
= 12.10%
QUESTION 5
Year 1 2
Long-term debt $50 million $35 million
Interest (5%) $50m *5% = $2.5 m $35m * 5% = $1.75 million
Tax saving /shields $2.5m * 40% = $1 million $1.75 m *40% = $0.7 m
QUESTION 6
Horizon value/Terminal value
= FCF in final year of projection * (1+ growth rate)/(Cost of equity – growth rate)
= $5.5 million * (1+3%)/(11.5%-3%)
= $ 66.65 million
QUESTION 7
Calculation of value of operations
Year 1 2
Free cash flow $5 million $5.5 million
Terminal value /Horizon value $66.65 million
Tax shields $1 million $0.7 million
TCF (Total Cash Flow_ ($5 + $1)million = $6 million ($5.5 + $66.65 + $0.7)m =
$72.85 million
Value of operations = 6,000,000/(1+12.5% )+ 72,850,000/(1+12.5)2
¿ $ 62,893,827
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QUESTION 8
Value of equity = Value of operations – debt value
¿ $ 62,893,827−$ 300,000
= $ 59,893,827
Highest offer price ¿ $ 59,893,827/15,000,000
¿ $ 3.99
As per the results, the existing stock price is below the computed value of $3.99,
therefore, the acquisition is found feasible (Johnstone, 2016).
QUESTION 9
Every acquirer estimates or projects future year cash flows using necessary information.
Subjective estimation and analysis of the information derived from varied sources about the prospective
growth rate and other variables differentiate free cash flow from one acquirer to another.
QUESTION 10
It did not consider the post-payback profitability however; it may be possible that a
project may takes lengthy time to recoup initial money invested, still, profit after the recovery
period may be higher (Alkaraan, 2017). Another drawback of the method is it did not consider
the time value of the currency and do not evaluates risk.
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REFERENCES
Books and Journals
Alkaraan, F., 2017. Strategic Investment Appraisal: Multidisciplinary Perspectives. In Advances
in Mergers and Acquisitions. Emerald Publishing Limited. 15(3). pp. 67-82.
Brooks, R., 2015. Financial management: core concepts. Pearson.
Frank, M.Z. and Shen, T., 2016. Investment and the weighted average cost of capital. Journal of
Financial Economics. 119(2). pp.300-315.
Johnstone, D., 2016. The effect of information on uncertainty and the cost of
capital. Contemporary Accounting Research. 33(2). pp.752-774.
Online
Acquisition valuation methods. 2017. [Online]. Available through:
https://www.accountingtools.com/articles/2017/5/4/acquisition-valuation-methods.
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