M&A Flashcards
When looking at an acquisition of a company, do you pay more attention to enterprise value or equity value?
EV. It’s the cash amount paid for the firm’s total assets.
What is accretion and dilution?
If a merger is accretive then the acquiring company’s earnings per share will increase after the merger.
Dilution is when EPS falls
When a company with a high P/E ratio acquires a firm with a lower P/E ratio, it is an accretive merger (this is only for an all stock deal)
A company is acquiring another company with a P/E ratio of 10. They finance the deal with 10% debt. Assume tax rate is equal to 40%. Would this be accretive?
Yes.
Looking at the after tax cost of debt:
(.6)(.1)=.06
Now look at the price you pay for the underlying earnings. You pay $10 for every $1 in earnings. So every $1 will earn you $.10
The deal will cost you .06 and earn you .10. Therefore your earning per share increased and the deal is accretive.
Company A (earnings yield 12%) acquires company B (earnings yield 13%). This is an all stock deal. Will this be accretive, dilutive, or neutral?
Earnings yield equals 1/Price to equity
1/.12=8.33
1/.13=7.69
Because it’s an all stock deal, when a company with a higher P/E ratio acquires a company with a smaller P/E ratio, the deal is accretive
Company A (earnings yield 12%) acquires company B (earnings yield 13%). This is an all debt deal. The tax rate is 30%. What is the highest rate of debt before the deal stops being accretive!
Earnings yield means that for every $1 you spend, you earn $.13.
So the after tax cost of debt must be less than 13%
13%(1-.3)=18.57%
What are synergies?
Area where the buyer gets more value out of a transaction than the financials suggest.
Revenue and cost synergies
What is a revenue synergy?
The combined company can cross sell products to new customers or up sell products to existing customers. It might also expand into new geographies as a result of the deal.
What is a cost synergy?
The combined company can consolidate buildings and administrative staff and can lay off redundant employees. It might also be able to shut down redundant stores or locations.
What is goodwill and how is it calculated?
Goodwill, a type of intangible asset, is created and reflects the value of a company that is not attributed to its other assets and liabilities.
Goodwill is calculated by subtracting the the targets book value from the equity purchase price paid for the company. This equation is sometimes referred to as the excess purchase price.
Accounting rules state that goodwill no longer be amortized each period, but must be tested once per year for impairment. Absent impairment, goodwill can remain on a company’s balance sheet indefinitely.
