Business Valuation

Question 1

What are the two reasons for a merger?

Answer 1

• Theoretical.

- Practical.

Question 2

Explain the theoretical reason for a business merger.

Answer 2

A merger will be accepted if it gives a NPV>0.

Question 3

Explain the 6 practical reasons for a business merger.

Answer 3

1. Elimination or reduction of competition.
2. Safeguarding sources of supply or sales outlets.
3. Access to greater economies of scale.
4. Access to some aspect of the target that is under utilised.
5. Risk spreading through diversification.
6. Synergy (“2+2=5”).

Question 4

What are the 4 main valuation approaches?

Answer 4

1. Asset based approach.
2. Dividend based approach.
3. Earnings based approach.
4. Cash based approach.

Question 5

How do you use the asset based approach?

Answer 5

Start with shareholders funds and process the adjustments in the question.

Question 6

What is the minimum a seller will sell for?

Answer 6

NRV.

Question 7

What is the maximum a buyer will buy for?

Answer 7

Replacement cost.

Question 8

What’s an issue with the asset based approach?

Answer 8

Doesn’t include the intangibles that aren’t on the balance sheet therefor may undervalue.

Question 9

What are the formulae for the dividend based approach?

Answer 9

Price=D0(1+g)/ke-g, or

Price=D0/yield

Question 10

In what situation is the dividend model useful?

Answer 10

Valuing a minority interest.

Question 11

What are two issues with the dividend model?

Answer 11

1. Assumes constant predictable dividend growth.

2. Ke must be estimated from a similar listed company.

Question 12

What are the formulae for the earnings based approach?

Answer 12

Price = Earnings x PE ratio, or
Price = EBITDA X EBITDA multiple - MV of debt + cash

Question 13

In what situation is the earnings model useful?

Answer 13

For valuing a majority interest and can incorporate synergies.

Question 14

What are three issues with the earnings model?

Answer 14

1. Erratic earnings may make the figure misleading.
2. Earnings can be manipulated.
3. PE and EBITDA multiple must be estimated from a similar listed company.

Question 15

How do you use the cash based approach to value a company?

Answer 15

PV of BEFORE interest cash flows to infinity discounted at WACC - MV of debt, or
PV of AFTER interest cash flows to infinity discounted at Ke.

Question 16

In what situation is the cash model useful?

Answer 16

For valuing a majority interest.

Question 17

Why are start-ups and technology companies difficult to value and how would you value them?

Answer 17

• Unknown profits, competition and volume of digital assets.

- Discounting future cash flows.

Question 18

Pro and a con from the bidders perspective when an acquisition is financed with cash?

Answer 18

+No dilution of control.

-Possible problems raising the cash.

Question 19

What is the bidders perspective when an acquisition is financed with shares? (1 pro 2 cons)

Answer 19

+Less demands on cash.

• Issue costs.
• Dilution of control.

Question 20

What is the bidders perspective when an acquisition is financed with loan stock?

Answer 20

• Obligation to pay interest.

- Gearing increases.

Question 21

What is the targets perspective when an acquisition is financed with cash?

Answer 21

• Can spend it straight away.
• Certain sum.
• Capital gains tax.
• No ongoing interest in the business.

Question 22

What is the targets perspective when an acquisition is financed with shares?

Answer 22

-Ongoing interest in the business.

Question 23

What is the targets perspective when an acquisition is financed with loan stock?

Answer 23

• Fixed income.

- Limited ongoing investment.

Question 24

What is a divestment?

Answer 24

When a firm sells a subsidiary.

Question 25

3 reasons why would a firm want to divest?

Answer 25

• To concentrate on core activities/lack of fit.
• To get rid of part of the business that is causing problems/diseconomies of scale.
• To raise cash.

Question 26

Name 7 restructuring methods.

Answer 26

• Management buy-outs.
• Buy-ins.
• Sell-offs.
• Spin-offs.
• Share repurchase.
• Debt for equity swap.
• Liquidation.

Question 27

How do you get growth from “Earnings retained and reinvested” and “Return on investments”?

Answer 27

Multiply them.

Question 28

One pro and one con of the NPV valuation method.

Answer 28

+Values the future cash flows of the company and takes into account both risk and time value of money.
-The inputs into the model are critical in arriving at a reliable estimate.

Question 29

What is an “offer for sale”?

Answer 29

Where shares are sold to an issuing house, which would then offer the shares onto the public.

Question 30

What is an offer for subscription (or direct offer)?

Answer 30

Where shares are offered directly to the public. Skipping the issuing house.

Question 31

Should you include deprecation when valuing a company using NPV?

Answer 31

No, depreciation is not a cash flow.

Question 32

Pro and con of getting a share issue underwritten.

Answer 32

Pro-Ensures all securities are sold and the company can be certain of obtaining the funds.
Con-The cost. Varies depending on the company in question and the state of the market but can range from between 1-2%.

Question 33

What is the most important thing to add to all the written answers?

Answer 33

LINK TO SCENARIO.

Question 34

Two key differences between an ICO and an IPO.

Answer 34

1. The investor receives a token (either a share or a utility token that gives an entitlement to use a service.)
2. Payment is made in a cryptocurrency such as bitcoin.

Question 35

Would an ICO ever be appropriate for a divestment?

Answer 35

Providing they are a new, potentially high growth project, yes it potentially is.

Question 36

What is the slow cat acronym for the SVA?

Answer 36

Sales
Life of project 
Operating margin
Working capital
Cost of capital
Assets fixed
Tax rate