Valuation Theory Questions: Final

Question 1

When should you use Discounted Cash Flow instead of Capitalized Cash Flow?

Answer 1

When business earnings vary significantly over time.

Question 2

Operating risks are independant of

Answer 2

financial risks (not always valid)

Question 3

What negative impacts on enterprise value does excessive financial leverage have?

Answer 3

Lost business and reduced cash flows - fear of insolvency
Lost or reduced credit - increases net trade working capital and a reduction in discretionary cash flow
Forego required operating expenditures in favor of debt servicing costs
Forego growth opportunities due to inability to raise capital at reasonable rates

Question 4

Which transaction costs does M&M not take into account?

Answer 4

Financial distress costs (expected cost of bankruptcy)
Agency costs (cost of monitoring, restrictive covenants)

Question 5

What are the three types of post-acquisition synergies?

Answer 5

Tangible
Intangible
Financial

Question 6

Describe Tangible synergies

Answer 6

Tangible Operating Synergies are the increase in EBITDA from incremental revenue opportunities, net of cost, or from cost savings, includes economies of scale

Question 7

Describe Intangible Operating Synergies

Answer 7

The reduced level of risk in achieving the prospective operating results, example: reduction in the risk of a critical manufacturing input through the acquisition of a supplier; enhanced long term growth prospects or strategic advantages not separately quantified, the anticipated benefits related to the acquisition of new leading-edge technology

Question 8

Describe Financial Synergies

Answer 8

Financial synergies are those related to the ability of a buyer to obtain lower-cost financing or to employ a more efficient capital structure than the target company could accomplish on its own, or as a result of combining the two entities (more on 496)

Question 9

What is fair market value?

Answer 9

The highest price available in an open and unrestricted market between informed and prudent parties acting at arms length under no compulsion to act, expressed in terms of cash.

Question 10

FMV Departure 1

Answer 10

Highest price available assumes all potential buyers have been solicited, cannot be known with certainty. Logical buyer cannot always or want to submit an offer (due to timing issues or financial constraints

Question 11

FMV Departure 2

Answer 11

Markets are not open and unrestricted. Can be external restrictions like government regulations (competition act) or internal restrictions imposed by companies board of directors or terms of shareholders agreements

Question 12

FMV Departure 3

Answer 12

parties are seldom fully informed. Prospective buyers, even with due dilligence, cannot always uncover all details about a prospective transaction. Seller is not always aware of a prospective buyers financial position nor the buyers specific post-acquisition synergies and quantifications the buyer expects to realize

Question 13

FMV departure 4

Answer 13

parties are not always prudent. the level of due diligence undertaken varies considerably between buyers, important factors that might have a material impact are often missed

Question 14

FMV Departure 5

Answer 14

parties do not always act at arms length

Question 15

FMV Departure 6

Answer 15

the seller or the buyer may be compelled to act, deterioting health of the owner or financial distress, buyer might feel compelled to act to prevent the target from becoming acquired by the competition

Question 16

FMV Departure 7

Answer 16

price may not always be in terms of cash, other forms of consideration can be used like promissary notes, earn outs, or a share exchange.

Question 17

Due dilligence

Answer 17

planning and preparation