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FNCE 465: Mergers and Acquisition > Valuation > Flashcards

Valuation Flashcards

1
Q

Valuation (2)

A
  • more of an art than science

- mispricing by financial market, target not traded, change of target operations and/or realize synergies

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2
Q

Comparable approach (1)

A
  • calculate key ratios or multiples for groups of similar companies or transaction as a basis for valuing target
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3
Q

DCF approach (1)

A
  • projects cash flow based on current financial statements and historical performance and considering strategy as well as environment
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4
Q

Four kinds of valuation (4)

A
  • multiple/comparable
  • DCF
  • value assets
  • strategize/transformational
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5
Q

Why do we need valuation (1)

A
  • firm (A+B) > firm (A) + firm (B)
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6
Q

How to calculate comparable approaches (4)

A
  • key ratios calculate each company
  • key ratios average for group
  • average ratio apply to absolute data for company of interest
  • applying ratio yield indicates market value
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7
Q

Average ratio (2)

A
  • industry ratio: 1.2

- total MV equity/ BV equity

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8
Q

Company comparable formulas (6)

A
  • MV equity / sales
  • MV equity / BV equity
  • MV equity/ net income (PE ratio)
  • price/ cash flow
  • price/ earnings growth
  • EV/ EBITDA
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9
Q

What is comparison sample (3)

A
  • industry comparison
  • companies
  • size/growth option/technological
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10
Q

Advantage and Disadvantage of comparable approach (7)

A

Advantage

  • easy to communicate
  • marketplace transaction are used
  • widely use for legal cases, fairness evaluation
  • allow for valuation of private firm

Disadvantage

  • easy to manipulate
  • too simple
  • difficult to find company comparable
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11
Q

NPV (1)

A
  • present value of all future cash flow discounted on cost of capital, minus cost of investment made over time compounded by opportunity cost of funds
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12
Q

Accounting vs financing objectives (2)

A
  • accounting: use stability stage profitability (buy: depreciate, sell: increase receivables)
  • financing: what should I pay/get? (buy: pay now, sell: do not receive cash)
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13
Q

Procedure of DCF (6)

A
  • presented in 5 to 10 years
  • financial analysis is performed to determined ratio and patterns
  • analysis of business economic of industry
  • based on analysis, cash flow is forecast
  • determined cost of capital
  • cash flow is discounted to obtain NPV
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14
Q

Cash flow consideration (8)

A
  • forecast earning
  • opportunity cost
  • sunk cost and overhead
  • externalities
  • taxes
  • book and tax depreciation
  • interest expense
  • capital expenditure
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15
Q

Forecasting earning (2)

A
  • all numbers come from accountants (different perspectives)

- earning is use to compute tax

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16
Q

Depreciation (5)

A
  • book and tax depreciation is different
  • tax authorities do not allow us to write off investment immediately
  • downside: keep table of book value of all asset
  • book value assets is I minus accumulated depreciation
  • subtract adjusted profit after tax, then add it back
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17
Q

Capital cost allowance (4)

A
  • item are pooled together
  • new investment = underappreciated cost capital
  • each year fraction is depreciated
  • never reach zero until items are all sold
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18
Q

Interest expense and actual taxes (2)

A
  • annual report: tax on EBIT- interest expense

- interest expense are tax deductible

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19
Q

Capital budgeting (4)

A
  • separate investing decision from financing decision
  • tax deductibility of interest expense is discounted rate
  • calculate cash flow as if expense is not deductible
  • calculate tax is EBIT only
20
Q

Tax (1)

A
  • marginal rate from earning another dollar
21
Q

Opportunity cost (2)

A
  • project might use resources that the company already owns

- reduce cash flow by the opportunity cost even if asset is idle

22
Q

Project externalities - cannibalization (1)

A
  • new projects might change cash flow of existing projects
23
Q

Sunk cost and overhead (2)

A
  • irrelevant decision to go forward

- overhead: irrelevant to capital budgeting and use accounting purposes

24
Q

Calculate free cash flow (1)

A
  • adjusted item that are non cash, subtract depreciation on tax (add back later), subtract CAPEX
25
Q

What happens at end of planning horizon (2)

A
  • project ends and equipment sold

- project continues: PV of future cash flow

26
Q

New working capital (4)

A
  • cash received + inventory + receivables - payables
  • accounting: sign of sales contract increase earnings
  • finance: cash not received until paid
  • increase EBIT and tax, does not increase cash flow,
    reduce unlevered net income by change in receivables
27
Q

Free cash flow things to consider (3)

A
  • do not ignore bad outcome
  • includes synergies
  • includes cost of restructuring, severance payment, retention, and advisory fee
28
Q

Cash and marketable securities (2)

A
  • interest earned is not part of FCF

- add cash to discounted FCF or subtract from debt

29
Q

Why do balance sheet ratio matter (4)

A
  • maintain target credit rating
  • financing constraints
  • loan convenant
  • EPS accretion vs dilutive
30
Q

WACC (4)

A
  • debt/ total capital * cost of debt + equity/total capital * cost of equity
  • cost of capital is determined by systematic risk of project
  • target WACC is relevant
  • financing proportion of total capital, cost of equity, after tax cost of debt
31
Q

Cost of debt (1)

A
  • after tax: deductible interest payment
32
Q

cost of equity (2)

A
  • equity > 1 riskiers

- RF - beta (RM-RF)

33
Q

beta (equity risk premium) (2)

A
  • regression analysis of historical price vs market

- measure of how much a stock moves when index moves

34
Q

Equity beta varies with leverage (1)

A
  • Be = BU * 1 + B(1-T) / S
35
Q

Asset beta measures risk which is constant (1)

A
  • Bu = Be + S / S + B(1-T)
36
Q

Beta calculation (4)

A
  • cannot use equity beta because firm has different capital structure
  • take comparative equity beta unlevered to get asset beta
  • relever average asset beta to get target equity beta
  • compute target cost of equity
37
Q

Leveraging and unleveraging beta (4)

A
  • levered beta = equity beta (regress stock price)
  • reflect industry risk and capital structure
  • unlevered beta = asset beta (unlevered equity beta)
  • reflect industry risk
38
Q

Capital structure (3)

A
  • use market value ratio for weights than book value of equity
  • optimal capital structure might change post M & A
  • intended financing proportion should reflect best judgement of firm’s financial structure in the future
39
Q

Changing leverage affect WACC (3)

A
  • weight
  • cost of debt
  • cost of equity
40
Q

Shouldn’t WACC work only when we finance the deal with debt vs equity (3)

A
  • No, WACC work only for projects not carbon copies
  • levered up, cost of debt increases
  • overall risk is important not the source of funds
41
Q

Where do inputs come from (2)

A
  • asset of beta

- capital structure weights

42
Q

Four basic model of terminal value (5)

A
  • no growth
  • constant growth
  • supernormal growth, then no growth
  • supernormal growth, then constant growth
  • growth perpetuity
43
Q

growth perpetuity (2)

A
  • C / r-g

- growth rate should at least be the inflation rate

44
Q

Other valuation techniques (6)

A
  • precedent acquisition
  • contribution analysis
  • real option
  • business metric analysis
  • liquidation/break up
  • leverage buyout model
45
Q

Real option valuation (8)

A
  • growth
  • expand scale
  • abandon
  • contract scale
  • timing
  • replace
  • switch
  • strategy
46
Q

real option analysis should be used in conjunction with DCF (3)

A
  • project that has negative NPV can be positive
  • DCF has downside/upsides
  • real option estimate upsides, minimize risk, recapture loss of DCF

FNCE 465: Mergers and Acquisition (7 decks)

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