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F3 Resit > Business Valuation > Flashcards

Business Valuation Flashcards

1
Q

What is a merger?

A

Joining together two or more entities

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2
Q

What is an acquisition?

A

One entity acquires a majority shareholding in another

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3
Q

What are the three types of mergers/acquisition?

A

Horizontal integration
Vertical integration
Conglomerate

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4
Q

What are the reasons for mergers/acquisitions?

A

Increased market share/power
Economies of scale
Combining complementary needs
Improving efficiency
Lack of profitable investment opportunities
Tax relief
Reduced competition
Asset-stripping
Big data opportunities

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5
Q

What is a synergy?

A

Defined as two or more entities coming together to produce a result not independently obtainable

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6
Q

What are the three synergy categories?

A

Revenue
Financial
Cost and other synergistic effects

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7
Q

What are some revenue synergies?

A

Market power
Economies of vertical integration
Complementary resources

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8
Q

What are some financial synergies?

A

Elimination of inefficiency
Diversification
Diversification and financing
Surplus cash

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9
Q

What are some cost synergies and other synergistic effects?

A

Economies of scale
Surplus managerial talent
Speed
‘boot strap’ or P/E game

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10
Q

What impact does a merger/acquisition have on the associated stakeholders?

A

Acquiring company’s shareholders - Creation of synergy should benefit them
Target company’s shareholders - Premium usually paid to encourage them to sell their shares
Lenders/debt holders - Debt usually repayable in the evenet of a change in control
Managers and staff - May give better career opportunities

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11
Q

Why does mergers/acquistions fail?

A

Fit/lack of fit syndrome – lack of fit in terms of management styles or corporate structure
Lack of industrial or commercial fit
Lack of goal congruence
‘Cheap’ purchases
Paying too much
Failure to integrate effectively
Inability to manage change

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12
Q

What are the tax implications of mergers/acquisitions?

A

Differences in tax rates and double tax treaties
Group loss relief
Withholding tax

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13
Q

What is the OECD?

A

Organisation for Economic Cooperation and Development
Organisation of developed countries whose main purpose is to maintain financial stability and expansion of world trade

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14
Q

What is group loss relief?

A

Members of a group of companies may surrender losses to other profitable group members for corresponding accounting periods
Tax planning primarily seeks to ensure losses are used within the group to save the most tax.
Group relief only available for losses and profits generated after a company joins a group.
Losses should be given to group companies who pay the highest rate of tax

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15
Q

What is withholding tax?

A

Government requirement for the payer of an item of income to withhold or deduct tax from the payment and pay that tax to the government.

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16
Q

What is the role of competition authorities?

A

Stengthen competition
Prevent or reduce anti-competitive activities – this is deemed to be the creation of an entity that will have 25% or more share of a market
Consider the public interest – national security, media quality, financial stability

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17
Q

What is divestment?

A

Disposal or part of its activities by an entity

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18
Q

What are the reasons for divestment?

A

Sum of the parts of the entity may be worth more than the whole
Divesting unwanted or less profitable parts
Strategic change
Response to crisis

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19
Q

What are the methods of divestment?

A

Sell-off (trade sale)
Spin off (demerger)
Management buyout

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20
Q

What is a sell-off?

A

Sale of part of an entity to a third party, usually in return for cash.
Used to divest of a less profitable business unit if an acceptable offer is received, protect rest of the business from takeover, generate cash in time of crisis.

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21
Q

What is a spin off?

A

New entity is created, where shares of that new entity are owned by the shareholders of the entity that made the transfer of assets into the new entity.

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22
Q

What are the reasons for a spin off?

A

Allow investors to identify the true value of a business that was hidden within a large conglomerate
Should lead to a clearer management structure
Reduce the risk of a takeover bid for the core entity

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23
Q

What is a management buyout?

A

Purchase of a business from its existing owners by members of the management team, generally in association with a financing institution

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24
Q

What are some consideration for management team before MBO?

A

Do the current owners wish to sell?
Potential of the business
Loss of head office support
Quality of the management team
The price

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25
Q

How do we finance a MBO?

A

Venture capitalists
Banks
Private equity firms
Other financial institutions

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26
Q

What are some exit strategies for equity holders?

A

Trade Sale
IPO
Independent sales to another shareholder

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27
Q

How is the value of a business affected?

A

Reported sales, profits and asset values
Forecasted sales, profits and asset values
Type of industry
Level of competition
Range of products sold
Breadth of customer base
Perspective

28
Q

What are the three different valuation methods?

A

Asset based valuation method
Earnings based valuation method
Cash flow based valuation method

29
Q

What is the asset based valuation method?

A

Company is viewed as being worth the sum of the value of its net assets
Method most useful when company is being broke up, rather than purchased as a going concern
Can be calculated as book value, replacement value or break up/net realisable value.

30
Q

What are the strengths of the asset based valuation method?

A

Valuations readily available
Provide a minimum value of the entity

31
Q

What are the weaknesses of the asset based valuation method?

A

Future profibalitiy expectations ignored
SFP valuations depend on accounting conventions, which may lead to valuations that are very different from market valuations
Difficult to allow for the value of intangible assets

32
Q

What are intangible assets?

A

lack physical properties and represent legal rights or competitive advantages developed or acquired by an owner

33
Q

What is intellectual capital?

A

total stock of capital or knowledge based equity that the entity possesses. It includes human capital, intellectual assts and intellectual property.

34
Q

How do we value intangible assets?

A

Market approach
Cost approach
Income approach

35
Q

What are the drawbacks of the CIV method?

A

CIV assumes future growth in income from intangibles will be constant at the cost of capital
CIV is based on profit rather than cash flow
CIV is based on an industry average return which might not be representative of the company being valued

36
Q

What is the earnings based valuation?

A

Earnings of the business are forecasted and then an ‘earnings multiple’ is applied.

37
Q

What is the P/E valuation method?

A

Values the equity of a business by applying a suitable P/E ratio to the business’s earnings.
P/E ratio is a simple measure of the company’s share price divided by EPS
An unlisted company will not have a market driven P/E ratio so an industry average or one for a similar company will be used as a proxy

38
Q

What are the strengths of the P/E valuation method?

A

Commonly used and well understood
Relevant for valuing a controlling interest in an entity

39
Q

What are the weaknesses of the P/E valuation method?

A

Based on accounting profits rather than cash flows
Difficult to identify a suitable P/E ratio, particularly when valuing shares of an unlisted entity
Difficult to establish the relevant level of sustainable earnings

40
Q

What is the cash flow valuation - DVM?

A

Value of the company/share is the PV of the expected future dividends, discounted at the shareholders required rate of return

41
Q

What are the strengths of the cash flow valuation - DVM?

A

Sound theoretical basis
Useful for valuing minority shareholdings where shareholder only receives dividends from the entity

42
Q

What are the weaknesses of the cash flow valuation - DVM?

A

Difficult to forecast dividends and dividend growth
Difficult to estimate cost of equity

43
Q

What are the strengths of the discounted cash flow method?

A

Theoretically best method of valuation
Used to place a maximum value on the entity
Considers the time value of money

44
Q

What are the weaknesses of the discounted cash flow method?

A

Difficult to determine an appropriate discount rate
Model assumes that the discount rate and tax rates are constant through the period
Difficult to forecast cash flows accurately

45
Q

What is the capital asset pricing model?

A

Enables us to calculate return from an investment given the level of risk associated with the investment
Gives a required return for a given level of risk

46
Q

What are the criticisms of the capital asset pricing model?

A

Single period model
Beta values are calculated based on historic data
Risk free rate may change over time
Assumes an efficient market where it is possible to diversify away unsystematic risk, and no transaction costs

47
Q

What are the two risks associated with a company?

A

Unsystematic risk
Systematic risk

48
Q

What is unsystematic risk?

A

Risk of company’s cash flows being affected by specific factors. Can be eliminated by diversification

49
Q

What is systematic risk?

A

Risk of the company’s cash flows being affected to some extent by general macro-economic factors. Cannot be eliminated.

50
Q

What are the implications of degearing and regearing beta factors?

A
  1. Equity beta will always be greater than its asset beta except
  2. If it all equity financed, when its equity beta and asset beta will be the same
  3. Company in the same area of business will have the same asset beta, but
  4. Companies in the same area of business will not have the same equity beta unless they also happen to have the same capital structure
51
Q

What is market efficiency?

A

Efficient market is one in which security prices fully reflect all available information. New information is rapidly and rationally incorporated into share prices in an unbiased way.

52
Q

What is weak market efficiency?

A

Past share price movements

53
Q

What is semi strong market efficiency?

A

All public information (including - past share price movements)

54
Q

What is strong market efficiency?

A

All information (all public and private)

55
Q

What are some pre-bid defences?

A

Communicate effectively with shareholders
Revalue non-current assets
Poison pill
Crown jewels defence
Change the articles of association to require ‘super majority’ approval for a takeover

56
Q

What are post-bid defences?

A

Appeal to their own shareholders
Attack the bidder
White knight
Counterbid – sometimes called a ‘Pacman’ defence
Refer the bid to the competition authorities

57
Q

What are the three forms of consideration for a takeover?

A

Cash offer
Share for share exchange
Earn-out

58
Q

What is a cash offer?

A

Target company shareholders are offered a fixed cash sum per share

59
Q

What is a share for share exchange?

A

Bidding company issues some new shares and then exchanged them with the target company shareholders

60
Q

What is an earn-out?

A

Consideration is split so that there is an initial amount paid at the time of acquisition, and the balance deferred

61
Q

What are the advantages of a cash offer?

A

Speed
Certainty about the bid’s value
Increased liquidity to target company shareholders
Lower cost to bidder

62
Q

What are the disadvantages of a cash offer?

A

Taxable chargeable gain
Target company shareholders are bought out
Financing problems

63
Q

What are the three main choices for raising the cash needed for a cash offer?

A

Existing cash reserves
Borrowings
Rights issues to existing shareholders

64
Q

What are the advantages of a share exchange?

A

Used to finance large acquisitions
No cash needed
Bootstrapping opportunity
Shareholder capital is increased

65
Q

What are the disadvantages of a share exchange?

A

Sharing gains
Price risk – risk that the market price of the bidding company’s shares will fall during the bidding process.

66
Q

What are Druker’s five golden rules to apply to post-acquisition integration?

A
  1. Ensure a ‘common core of unity’ is shared by the acquired entity and acquirer
  2. The acquirer should not just think ‘What is in it for us?’, but also ‘What can we offer them?’
  3. Acquirer must treat the products, markets and customers of the acquired entity with respect
  4. Within 1 year, the acquirer should provide appropriately skilled top management for the acquired company
  5. Within 1 year, the acquirer should make several cross-entity promotions of staff
67
Q

What is bootstrapping?

A

Valuation of a company post-acquisition by applying the larger company’s higher P/E ratio to the earnings of the combined company

F3 Resit (3 decks)

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