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Valuation of a Firm in case of Mergers & Acquisitions-B.V.Raghunandan
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Valuation of a Firm in case of Mergers & Acquisitions-B.V.Raghunandan

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Deals with the intricate process of valuation of a firm in case of Mergers & Acquisitions

Deals with the intricate process of valuation of a firm in case of Mergers & Acquisitions

Published in Economy & Finance
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  • 1. B.V.Raghunandan, SVS College, Bantwal. Karnataka-India Valuation of a Firm in case of Mergers & Acqusitions
  • 2. Valuation of a Firm
    • Most important aspect
    • Crucial for the success of M&A
    • Selecting a suitable method of Valuation
    • Determining the Price payable
    • Mode of Payment
    • Forecasting future income is a vital element of any method of valuation
  • 3. Valuation Approaches
    • Discounted Cash Flow determines the value of the firm by ascertaining the present value of future cash flows
    • Comparable Firm determines the value of the firm at the value of a similar firm in the same industry
    • Adjusted Book Value estimates the value of the firm at the sum of market value of assets and liabilities as a going concern
    • Option Pricing Model regards the equity of a taken over company as an option and values it like an option
  • 4. Merger as a Capital Budgeting Decision
    • Capital Budgeting involves acquiring fixed or long-term assets
    • Discounted Cash Flow Approach is used determine the profitability of an asset or viability of a Project
    • M&A involves acquiring the target firm comprising a large number of assets and liabilities
    • It is a very long-term investment
    • Valuation of the target firm is done in the light of additional cash flows generated additionally by the acquisition
  • 5. Steps in Evaluating M & A Decision
    • Determine the Cost of Acquisition
    • Forecast the Incremental Cash flows for the future period
    • Calculate the cost of capital which can be used as the rate of discount
    • Obtain the present value of future free cash flows
    • Estimate the Terminal Value
    • Compute the present value of the terminal value by using the rate of discount
    • Add up the present value of future free cash flows and the present value of Terminal Value
  • 6. A. Determining Cost of Acquisition
    • Market Price of Equity Shares Allotted
    • (+) Payment to Preference Shareholders
    • (+) Payment to Debenture holders
    • (+) Payment of other Liabilities
    • (+) Unrecorded Liabilities
    • (+) Dissolution Expenses
    • (-) Sale of Assets
  • 7. B. Forecasting Cash Flows of Future
    • Cash Flow
    • Free Cash Flow (FCF)
    • Operating Free Cash Flow (OFCF)
    • Free Cash Flow to the Firm (FCFF)
    • Free Cash Flow to Equity (FCFE)
  • 8. Cash Flow
    • It is the net profit arrived at after removing non-cash items like depreciation and amortisation of intangible assets and expenses shown in the Balance Sheet
    • Cash Flow has become more reliable as manipulation becomes difficult with cash. As it is said, cash is a fact while profit is an opinion
    • It is calculated by adding back depreciation and amortisation of expenses to the Profit after Tax…
    • Profit after Tax …………
    • (+) Depreciation …………
    • (+) Amortisation of Expenses …………
    • --------------------
    • Cash Flow ………
    • --------------------
  • 9. Free Cash Flow
    • It is a cash flow that is arrived at after providing for capital expenditure and the net working capital
    • It is a better measure since it considers the operating expenses and also the capital expenditure
    • It is also more realistic in that it takes care of the net working capital requirements
    • It is also a good measure because it shows the profitability that is relevant to both the equity shareholders and the lenders
  • 10. Calculation of Free Cash Flows (FCF)
    • Profit after Tax …………
    • (+) Depreciation …………
    • (+) Amortisation of Expenses …………
    • --------------------
    • Cash Flow …………
    • (-) Purchase of Fixed Assets …………
    • (-) Increase in Net Working Capital …………
    • --------------------
    • Free Cash Flow …………
    • --------------------
  • 11. Operating Free Cash Flows (OFCF)
    • It is the cash flow that takes into account only the operating income and operating expenses
    • Other items like interest, other income etc are ignored
    • It is a measure that shows the profitability of the main operation and is not affected by the investment activities and financing activities
    • This is used when only the manufacturing facilities are taken over through M&A
  • 12. Calculation of OFCF
    • Profit after Tax …………
    • (+) Depreciation …………
    • (+) Amortisation of Expenses …………
    • --------------------
    • Cash Flow …………
    • (-) Purchase of Fixed Assets …………
    • (-) Increase in Net Working Capital …………
    • --------------------
    • Free Cash Flow …………
    • (+) Interest Paid …………
    • (-) Interest Received …………
    • (-) Other Income …………
    • --------------------
    • Operating Free Cash Flow ………….
    • --------------------
  • 13. Free Cash Flow to the Firm (FCFF)
    • It takes into consideration all the cash items including interest, items arising out of capital expenditure and also investment in marketable securities
    • The decision on M&A takes FCFF and its discounted values for the purpose of determining the value of the firm
    • There are many firms where investment, capital expenditure and capital receipts and other incomes are as regular as any other operating item
    • Thus, FCFF is the right cash flow for the purpose of valuation of the firm
  • 14. Computation of FCFF
    • Profit after Tax …………
    • (+) Depreciation …………
    • (+) Amortisation of Expenses …………
    • --------------------
    • Cash Flow …………
    • (-) Purchase of Fixed Assets …………
    • (-) Increase in Net Working Capital …………
    • --------------------
    • Free Cash Flow …………
    • (+) Non-Operating Income ………….
    • (+) Decrease in Marketable Securities …………
    • --------------------
    • FCFF …………
    • --------------------