5) SYNERGIES & DEAL VALUATION

Question 1

Income statement: EBITDA

Answer 1

= Total revenues – COGS – Selling, general & admin expenses

Question 2

Income statement: EBIT

Answer 2

= EBITDA – Depreciation

Question 3

Income statement: EBT

Answer 3

= EBIT – interest (interest expense + interest income)

Question 4

Income statement: Net Income

Answer 4

= EBT – taxes

Question 5

FCFE

Answer 5

= NPAT + Depreciation – CAPEX – Increase in Working Capital + Increase in Debt

Question 6

FCFF

Answer 6

= FCFEE + Interest tax shield – increase in net debt

Question 7

Balance sheet: Net Working Capital =

Answer 7

(Current Assets – Cash and marketable Securities) - (Current liabilities – current portion of interest-bearing liabilities)

Question 8

Balance sheet: dif between assets and liabilities on balance sheet =

Answer 8

value of the equity belonging to the firm owners

Question 9

Balance sheet: Total current assets =

Answer 9

Cash + acc receivable + inventories + deferred income taxes

Question 10

Balance sheet: Net PPE

Answer 10

= PPE - accumulated depreciation

Question 11

Balance sheet: Total Assets

Answer 11

= Total current assets + Net PPE + other assets

Question 12

Balance sheet: Total current liabilities

Answer 12

= acc payable + accrued expenses + short term debt

Question 13

Balance sheet: total liabilities =

Answer 13

total current liabilities + long term debt + other long term liabilities

Question 14

Balance sheet: Total liabilities and equity

Answer 14

= common stock + retained earnings

Question 15

CF statement: Net cash from operating activities

Answer 15

= net income + depreciation + change in inventory, accounts receivable, accounts payable, accruals

Question 16

CF statement: Investing activities

Answer 16

= investment in PPE

Question 17

CF statement: net cash from financing activities

Answer 17

= change in short term + long-term debt + change in common stock + common dividends

Question 18

CF statement: End Cash

Answer 18

= net cash from operating activities + net cash from investing activities + net cash from financing activities + start cash

Question 19

Why do we need to calculate the implied tax rate?

Answer 19

to determine the interest tax shield (ie, proportion of EBT paid as Tax)

Question 20

Implied tax rate =

Answer 20

taxes/(EBIT- interest expenses) as a %

Question 21

Debt to capital ratio

Answer 21

= total debt / [total debt + (shares outstanding x share price)]

Question 22

Interest tax shield

Answer 22

= interest expense*(1-implied tax rate)

Question 23

what can you use the debt to capital ratio for

Answer 23

to estimate the next year’s increase in net debt:

debt: capital ratio (estimate x (capex(estimate from growth rate) - depreciation(estimate from growth rate))

Question 24

Synergies

Answer 24

value created through inorganic growth that a company could not otherwise achieve

Question 25

How do synergies arise?

Answer 25

combination of multiple firms’ resources and capabilities

Question 26

In strategic MandA when does the deal go ahead?

Answer 26

expected synergy gains exceed the costs and risks of undertaking M&A (expected synergy gains > costs & risks of M&A)

Question 27

Whether a synergy is specific and measurable is linked to likelihood

Answer 27

of its post-merger implementation.

Question 28

Horizontal mergers

Answer 28

MandA btw companies producing the same/similar products/services

Question 29

Why are horizontal mergers common in mature and declining industries?

Answer 29

i. Low overall growth and excess capacity | ii. Tough competition, price pressures

Question 30

What does empirical evidence for horizontal mergers show?

Answer 30

benefits are short lived and difficult to sustain

Question 31

For horizontal mergers, by merging these companies increase their relative market share which has benefits to them in 4 ways

Answer 31

1) increased market power, 2) bargaining power over 3) suppliers and customers, 4) strategically crowding out competitors

Question 32

Horizontal mergers achieve cost savings from

Answer 32

utilisation and scale efficiencies: the related comapnies can reduce back-office costs and other direct operational fees (listing fees) + optimise capaacity usage and network efficiency

Question 33

Horizontal mergers --> cost savings net effect

Answer 33

company can produce more or the same product/service at a lower cost per unit, ie scale economies. May also be synergies through scope economies, learning economies, etc.

Question 34

Synergies in place

Answer 34

synergies considered ‘realisable’ through the combination of | EXISTING resources and capabilities of the merging entities.

Question 35

Whilst there's still risk attached to the achievement of synergies in place the resulting CFs may be

Answer 35

estimated and reasonably expected to be implemented upon successful closure of the bid.

Question 36

Real option synergies

Answer 36

depend on another outcome, or trigger, to occur.

Question 37

Types of real option synergies

Answer 37

option to grow, exit, defer or alter some form of operation in response to another factor.

Question 38

the optionality for real option synergies can be viewed as

Answer 38

flexibility to the manager and thus more valuable than a synergy in place (no flexibility)

Question 39

how to value option synergies to capture full value:

Answer 39

``` option framework (such as binomial tree or Black-Scholes model) ```

Question 40

Synergies in place can be classified as

Answer 40

OPERATIONAL SYNERGIES 1) revenue enhancement 2) cost savings 3) asset sales - tax reductions FINANCIAL SYNERGIES

Question 41

Why is it beneficial to classify synergies?

Answer 41

Guides analyst in determining how the acquisition meets the strategic objectives of the acquiring firm. Also sets the framework for synergy valuation as the risk varies across different synergies

Question 42

Riskiness of operational synergies:

Answer 42

As a rule of thumb, asset sales are generally considered the least risky (near risk-free), then cost savings and revenue enhancement being the most risky synergies.

Question 43

How do analysts typically measure the necessary adjustments for control and liquidity?

Answer 43

Usually use comparable transactions approach to measure the cost of control and liquidity

Question 44

Interpretation of results from this form of analysis (comparable transactions approach to measure necessary adjustments for control and liquidity) must be considered in the context of

Answer 44

the differences between the firms in the comparable transactions set and the firm under analysis.

Question 45

consolidation mergers

Answer 45

subcategory of horizontal mergers take place between firms in highly fragmented industries with a large number of small firms

Question 46

Vertical mergers

Answer 46

MandA between companies involved in the production of the same product at successive stages of the value chain

Question 47

Vertical mergers and their synergies

Answer 47

Vertical merger to create value should also lead to revenue enhancement and new growth opportunities

Question 48

Economic rationale for vertical mergers rests on

Answer 48

comparative efficiency of vertical integration in terms of technical and coordination efficiency

Question 49

Industry blurring merger

Answer 49

combines firms operating at different stages of different vertical chains (ie banks and insurance, media and internet)

Question 50

3 advantages of using trading multiples to find intrinsic value

Answer 50

1) simple, widely used 2) based on public market prices 3) provides a 'rel val'

Question 51

4 disadvantages of using trading multiples to find intrinsic value

Answer 51

1) peer firm identification is a challenge 2) earnings subject to manipulation 3) market may be wrong 4) not an 'absolute' valuation

Question 52

2 advantages of using transaction multiples

Answer 52

1) captures control premium | 2) may show trends, help determine bid strategy

Question 53

control premium

Answer 53

amount that a buyer is sometimes willing to pay over the current market price of a publicly traded company in order to acquire a controlling share in that company.

Question 54

3 disadvantages of using transaction multiples

Answer 54

1) transactions are rarely direct comparables 2) premia fluctuate over time 3) harder to identify suitable sample

Question 55

6 advantages of using the DCF

Answer 55

1) Theoretically sound, 2) rigorous, analytical, 3) cash focused, 4) forward-looking, 5) multiperiod, captures time value of money 6) can value segments or synergies separately

Question 56

4 disadvantages of DCF

Answer 56

1) time consuming 2) can be fudged 3) highly sensitive to inputs 4) Terminal value captures significant part of value

Question 57

Implementation costs for synergies need to be accounted for on

Answer 57

an after tax basis

Question 58

Vsynergies in plac

Answer 58

= sum of (After-tax synergies)/(1+RADR^t)

Question 59

RADR: no material risk

Answer 59

use risk-free rate (ie, certain asset sales like inventory reductions)

Question 60

RADR: as risky as EBIT

Answer 60

Cost of debt (lower risk cost reductions)

Question 61

RADR: as risky as enterprise FCF

Answer 61

WACC (medium risk cost reductions, lower risk revenue enhancements)

Question 62

RADR: as risky as equity FCF

Answer 62

Cost of equity (higher risk cost reductions, med risk rev enhancements)

Question 63

RADR: More risky than equity FCF)

Answer 63

Hurdle rate (minimum rate of return required on a project or investment)

Question 64

Liquidity

Answer 64

the ability to enter/exit an investment position quickly

Question 65

Illiquidity or lack of a market for an asset, leads to a discount just large enough to

Answer 65

to purchase the non-traded asset rather than an identical marketable asset

Question 66

Control is:

Answer 66

– Control is the right to: o Direct the strategy and activities of a firm o Allocate the resources of the firm o Distribute the wealth of the firm – Control is a call option on the alternate strategies available

Question 67

– The purchase premium should not be

Answer 67

used as a proxy for the control premium | – The control premium is the price of the control right