M & a Valuation Theories and Application

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M & A Valuation Theories and Application The leading methods used in the valuation of a firm for the purpose of merger analysis are 1) the comparable companies or the comparable transactions approach; 2) the discounted cash flows spreadsheet method which will, probably, be the most familiar to you as it does not differ that much from the capital budgeting methods of analysis using Net Present Value (NPV); and 3) the formula approach. In the comparable companies approach, a number of market ratios--such as market value of equity over sales, market value of equity over book value per share, P/E ratio--are calculated for several similar companies, preferably from the same industry. (To decide on the comparability issues, we should consider size, similarity of the products, age of the companies, and recent trends in sales.) Based on these individual companies' ratios, we then compute the average ratios and apply those, to determine the estimated market value of the target company. It's rather simple, and based on common sense. The comparable transactions analysis applies a similar type logic to answer this single-most-important question: how much to offer? To do the analysis, we would collect the data for the companies involved in the same type of merger transactions, and then use this market information as the basis for negotiations. Please notice that we use not the market price of stock after the announcement of the bid, but the actual price paid! Both discounted cash flows and the formula approach methods use the same concept that the use of discounted projected cash flows represent the best formal approach to target company valuation. Net After Tax Income (or Loss) Plus Depreciation Minus New Capital Expenditures Plus or Minus Net Change in Working Capital (As Accounts Receivable and Inventories Increase, the Firm…...

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