Case 48 Sun Microsystems Done by Nour Abdulaziz Maryam .docx

Case 48: Sun Microsystems
Done by: Nour Abdulaziz
Maryam Barifah
Shrouq Al-Jaadi
Balqees Mekhalfi
Yara El-Feki
Introduction
•In 2009, Oracle was planning to acquire Sun Microsystems.
•This acquisition would allow Oracle;
•to further diversify their brand, customers and acquire various
new platforms that would be added to their portfolio such as
MySQL, Solaris and Java.
•Oracle originally placed an offer of $9.50 per share price
which is considerably higher than Sun Microsystem’s price that
is $6.69.
•This will cut the production costs and make the company more
efficient throughout all the value chain.
•Oracle aimed to capitalize on Sun Microsystem’s decline by
getting particular assets or the whole company at the deflated
price.

Is Sun Microsystems a good strategic fit for Oracle? Should
Oracle acquire Sun Microsystems?
- as it will allow them to achieve their vision of becoming the
Apple of the software industry.
- it will allow the company to deliver high-quality customer
products by combining both hardware and software components,
hence reducing the consumer setup process.
Continue
It will provide Oracle with the needed expansion.
-This acquisition fits Oracle’s overall strategy which is to
improve through acquiring and effectively integrating other
companies

Worth of Sun Microsystems and Valuation Approaches
To know how much Sun Microsystems worth, we must find the
Stand Alone Value of the company.
The Stand Alone value represents the present value of Sun
Microsystem individually before factoring the synergy that
would be created when Oracle acquires Sun.
Another method is the value of Sun Microsystem with
synergies, which after being acquired by Oracle, must be found.
This is done to see whether or not the acquisition was a proper
strategic decision or not
Another method of valuing the Sun Microsystem is through the
comparative company analysis (CCA). That is done through the
thorough assessment of rival and peer businesses of similar size
and industry.
Finally, the acquisition price, which is the price that is paid to
the target when it is first acquired, is also used as a separate
method of valuation. The value of the acquisition price ranges
between the values of the stand-alone and the synergies.
USING THE DCF
To be able to find the values of both, the Stand Alone and the
synergies, we have decided the best way to do so is by
calculating the discounted cash flow (DCF) by using the

multiples and the perpetuity growth methods and finding the
average of both.
DCF Using Multiples MethodDCF Using Perpetuity Growth
MethodIt does not consider long-term growth rate or the
economics of business.This method seems inaccurate as the
company assumes a certain growth rate will remains the same
2014 onwards (forever) which is unrealistic.It is considered a
challenging method to use as it is very difficult to identify truly
comparable companies.
USING THE WACC
The weighted average cost of capital (WACC) is the average of
the cost of individual sources of capital. The capital is
comprised of equity that has been invested, or simply debt that
lenders decided to invest in; with each source of equity being
proportionally weighted.
WACC can be defined as the minimum rate of return.
Companies must generate returns greater than their WACC to be
above the break-even point. In case a company goes below, they
would enter a deficit.
The formula: WACC = Wd x Rd x (1-T) + We x Re
Wd= weight of debt (Debt/(Debt + Market Capitalization))
Rd= cost of debt
We= weight of equity (1-Wd or 1-%Debt)
Re= cost of equity (Using CAPM) = Rf + Beta x (Rm).
T= tax rate = 35%
Providing us with a WACC of 12.05%.

Comparable Companies Analysis (CCA)
The analysis will be based on the following companies. Apple,
Dell, Hewlett-Packard (HP), Intel and International Business
Machines (IBM).
In Exhibit 9 the levered beta of comparable companies are
given, reflecting an industry’s median 1.12 and a levered beta
of Sun Microsystems of 1.73
Calculated the debt to equity (D/E) ratio to get the unlevered
beta, using a tax rate of 35% as assumed in question 2,
showcasing an industry median of 9.35% and an industry’s
unlevered beta of 1.58, while Sun Microsystems’ (D/E) ratio is
25.44% and its unlevered beta is 2.13
Calculated the cost of equity using capital market structure[1]
using the risk free rate of 2.82% and market premium of 6%
The WACC was calculated to conclude an industry’s median of
9.50% against Sun Microsystem’s that is of 12.05%
This indicates that investing in the company is much riskier
compared to its rivals in the same industry.

Multiples of the Comparable CompaniesEBIT MultipleEBITDA
MultipleSales Multiple Sun Microsystems-1.41-
13.511.72Median 9.406.281.39
Incorporated the averages of these multiples to calculate the
firm’s implied enterprise value.
Used the average of the EBIT, EBITDA, and Sales for the
comparable companies analysis (for the years 2007 and 2008).
We reached an average share price of $13.06
Economic fundamentals reflected in the multiples
We used the 10 years U.S. treasury bills yield as risk-free rate
used as growth rate.
When calculating the average share price, our implied enterprise
value was calculated based on the average of the multiples.
There could be a miscalculation of the actual worth of the firm
because some of the companies are much more financially
stable in comparison to Sun Microsystems such as Apple and
Dell.

Stand-Alone Sensitivity Analysis:
Synergy Value Sensitivity Analysis
Summary of Results

What price should be offered by Oracle?Sun Microsystems
Implied Offer PricePerpetuity Growth MethodExit Multiple
MethodSun Microsystems Share PriceDCF using the Standalone
Value$7.40$9.44$8.42DCF using the Synergy Value
$12.79$16.32$14.55Average CCA$13.06Current Offer Price by
Oracle$9.50
Oracle could offer Sun Microsystems a price within the range of
$8.42 to $14.55
The price per share using the comparable company analysis
($13.06) method and the current offer price by Oracle ($9.50)
are both included within this range
We believe that the optimal price that should be offered by
Oracle should be $11.38 per share.
Conclusion
The acquisition of Sun Microsystems by Oracle,
Would add additional platforms to their portfolios such as
MySQL, Solaris, and Java.
The combination of the two companies would allow Oracle to
expand its market share by dealing with lower-end consumers.
Sun Microsystems calculated WACC is equal to 12.05% which
means that investing in Sun would provide an appealing
however with a high risk.
Discounted cash flow method and the multiples valuation
method was used to know which price should Oracle give to Sun
Microsystem’s shares.

1
[Type text] [Type text] [Type text]
19
Student Name and ID #
Tuleen Basrawi 1310186
Lara Hamza 1310042
Heba Bannoub 1320048
Course
Financial Policy
BNFN 4304
Section
1
Assignment #
Case 48: Sun Microsystems
Due Date

Instructor
Masood Aijazi
Executive Summary
Oracle is among the leading, legitimate database management
system vendors including other related programming services.
Oracle wants to acquire Sun Microsystems. Sun Microsystems
deals with storage, hardware equipment, and offers various
services at the enterprise level. If the acquisition succeeds then,
the combination will be similar to Walmart but operating in the
programming industry. The ultimate purpose of this report is to
evaluate whether Sun Microsystems is a perfect match for
Oracle and the best price to settle at. With regards to Sun
Microsystems, Base-Case or Stand Alone and the expected
synergies after acquisition were used to make valuations. Ways
were devised to better value Sun Microsystem. First, debt and
market capitalization were included to arrive at $6.20 billion
enterprise value. In the second case, a multiple analysis focused
on comparable companies was utilized. The objective was to
establish the enterprise value estimated at $3.87 billion. Third,
discounted cash flow method was used. The enterprise value

was estimated at $4.53 billion as stand-alone which is around
$8.95 billion. It is notable that the values from the various ways
are different and is due to the assumptions.
Table of Contents
Executive Summary 3
Introduction 5
1. Is Sun Microsystems a good strategic fit for Oracle?
Should Oracle acquire Sun Microsystems? 5
2. How much is Sun worth? What approaches would you use to
place a value on Sun Microsystems? (Hint: Stand-Alone Value,
Acquisition Price and Value with Synergies) 7
The Stand Alone and Value with Synergies methods for
valuation using the WACC was calculated as follows: 8
Steps for WACC calculation are seen in the excel sheet: 9
3. Assuming a discounted cash flow valuation: 9
a. What rate of return should Oracle require on the
acquisition? 10
b. What base-case cash flows do you forecast? 10
c. What is your estimate of terminal value? 11
d. What is the enterprise value of Sun Microsystems? What is
the equity value? 12
4.Conduct a compare companies or multiples analysis to value
Sun. What economic fundamentals are reflected in the
multiples? 12
Multiples of Comparable Companies 13
Multiples Analysis 15
Economic Fundamentals 16
5. Identify the synergies and conduct a sensitivity analysis to
estimate the effect of synergies on enterprise value. 16
The below table shows the sensitivity analysis for the two
approaches: 20
Stand-Alone Sensitivity Analysis: 20
Synergy Value Sensitivity Analysis: 21
Summary of Results: 21

6. If a competing bidder appears, how high a price should
Oracle be willing to offer? 22
Conclusion 23
Introduction
The computer industry is extremely competitive and the
organizations are always searching for new way to evolve to be
a step ahead of the competition at all times. In 2009, Oracle was
planning to acquire Sun Microsystems. This acquisition would
allow Oracle to further diversify their brand, customers and
acquire various new platforms that would be added to their
portfolio such as MySQL, Solaris and Java. Oracle originally
placed an offer of $9.50 per share price which is considerably
higher than Sun Microsystem’s price that is $6.69. In addition
to this, Oracle levered the company’s value with the acquisition
of Sun Microsystems through complementing their system with
hardware manufacturing. This will cut the production costs and
make the company more efficient throughout all the value chain.
The acquisition will pool Oracle’s leading position in the
software area with Sun Microsystem’s proficiency in hardware
and networking. Moreover, Oracle aimed to capitalize on Sun
Microsystem’s decline by getting particular assets or the whole
company at the deflated price. The main issue that Oracle
needed to confront was to make an accurate valuation model to
think of a reasonable price for Sun Microsystems share price.
Additionally, Oracle had to ensure that acquiring Sun
Microsystem would convey benefits and productivity to its
operation.1. Is Sun Microsystems a good strategic fit for
Oracle? Should Oracle acquire Sun Microsystems?
Oracle’s finance position was better in 2009 unlike Sun
Microsystems. Sun Microsystems poor finance position was
attributed to steady market share loss in the hardware segment.
To improve the revenues, Sun tried to leverage software systems
by making the Java Solaris, and acquiring MySQL. However,
the improved performance as a result of the leveraging was not
long-term. The onset of the recent global finance crisis

adversely affected their financial performance. The only option
for the company was accepting an acquisition (Nicalao, 2012).
Oracle would greatly benefit from the acquisition.
Even though Oracle and Sun are classified in the same industry,
they deal with different products. Oracle manufactures software
while Sun specializes in networking and hardware. The
acquisition is therefore, vertical integration. As a result, Oracle
will benefit from products diversification (Kumar, 2012). In
1997, Oracle used Solaris and Java language, Sun’s products.
The competition between MySQL and Oracle database systems
was indirect as they targeted different customers. Adding
MySQL will thus, contribute to the portfolio of Oracle. The
company will be able to attract the high-end clients and sell the
software to them. Oracle could further add Sun’s strong position
in the software industry in relation to Solaris systems, Java, and
MySQL to its portfolio.
The technology industry began with hardware, software,
peripherals and storage. Uncertain segments however, groped up
following industrial development in the new millennium. The
other businesses in the technology sector have been influenced
by Apple’s store which enables the customers to purchase the
needed software, hardware and peripherals from one store to
reconsider their strategies in business development.
Sun is perfect match for Oracle. The acquisition will enable
Oracle to achieve the vision of becoming a market leader in the
technological sector by offering hardware and software
components. The acquisition will also help to distribute high-
quality products, reducing the customer set-up procedure.
Acquiring Sun Microsystem will also create room for
expansion. In fact, the acquisition justifies Oracle's strategy of
improving via acquisition and integrating with other companies.
Oracle is not new to acquisition strategy. The company has
spent at least $30 billion acquiring companies since 2005 hence,
familiar with acquisition concept. The company has the ability
to study the intended company and perceive possible synergies.
Basing on the benefits of the acquisition, Sun Microsystem is

therefore considered the best proposal for Oracle.
2. How much is Sun worth? What approaches would you use to
place a value on Sun Microsystems? (Hint: Stand-Alone Value,
Acquisition Price and Value with Synergies)
It is prudent to choose the best approach for valuing Sun
Microsystem before ascertaining its worth. The recommended
approaches are stand-alone value, acquisition price, and value
with synergies. Stand-alone is Sun’s present value without
considering the synergy as a result of the acquisition. It is the
excess money received by Sun’s shareholders. It is a way of
valuing a firm before any merging or acquisition takes place
(Brigham & Ehrhardt, 2013). The value is important to confirm
where the target company is overvalued or undervalued by
comparing it against the current share prices.
Second, Sun’s value after the acquisition must be calculated.
The value helps to verify whether the acquisition was
appropriate or not. The company’s value included in the deal
will grow if the acquisition is established to be a perfect
strategic decision. This is referred to as the synergy effect. The
cost saving as well as the gain in revenue and efficiency that is
attained when merging occurs is indicated via synergies (see
Q.3.2, Q.3.3, Q.5.2, and Q.5.3 in spread sheet and question 5).
Comparative analysis or trading comps is another method of
valuing Sun Microsystem. In comparative analysis, the
competitors and peer businesses of same size and in same
industry is assessed (Brigham & Ehrhardt, 2013). Acquisition
price can also be used for valuation. The acquisition price value
ranges between the values of stand-alone and synergies. The
best way to figure out stand-alone and synergies values are by
calculating the discounted cash flow (DCF) by employing
multiples and perpetuity growth methods and finding the
average of both. These methods however, have challenges. First,
the DCF using the multiples method does not consider long-
term growth or the econometrics of business. It is also difficult
to identify comparable companies (Brigham & Ehrhardt, 2013).
Second, the DCF using the perpetuity growth method appears

inaccurate as the company assumes a certain growth rate will
remain the same which is impossible.The Stand Alone and
Value with Synergies methods for valuation using the WACC
was calculated as follows:
Weighted Average Cost of Capital (WACC) refers to cost of
individual sources of capital when averaged. It is the minimum
return rate from the invested capital (Brigham & Ehrhardt,
2013). The capital considered when calculating WACC is debt
and equity. Returns greater than WACC must be generated to
stay above the break-even point. Going below it, would create a
deficit. WACC must be calculated for the landers and
shareholders to able to approximate the returns that their
investments might yield. The spreadsheet shows the steps for
calculating WACC.Steps for WACC calculation are seen in the
excel sheet:
The formula: WACC = Wd x Rd x (1-T) + We x Re
Wd= weight of debt
Rd= cost of debt
We= weight of equity
Re= cost of equity
T= tax rate
To calculate WACC, the weight of debt in the capital structure
must be calculated using: Debt/ (Debt + Market Capitalization)
(The numbers can be found in exhibit 9.
Then, a calculation of the weight of equity must be done by: 1-
Wd or 1-%Debt
Furthermore, the corporate bond yield from Exhibit 10 is
used for the BB+ ratings since in Exhibit 9 it was shown that
the bond rating for Sun Microsystem is Ba1 (Moody’s), which is
equivalent to BB+ (S&P).
Moreover, the cost of equity is calculated by using the
Capital Asset Pricing Model: Rf + Beta x (Rm).
All using the following data: a market risk premium (MRP) of
6% (assumed) and the 10-year Treasury Yield as the risk-free
rate (from Exhibit 10) of 2.82% and a Beta of 1.73 (the levered
beta for Sun Microsystem found in Exhibit 9).

Finally, determining the WACC using the assumed tax rate of
35%, providing us with a WACC of 12.05%.3. Assuming a
discounted cash flow valuation:
The Discounted Cash Flow (DCF) Method is considered to the
be the superior valuation techniques to use in case of mergers
and acquisitions compared to the comparable company’s
analysis (CCA) since it is considered to be forward looking and
will consider time value of money. DCF in addition focuses on
cash flows instead of profits, and reflects on other non-cash
charges such as depreciation and amortization and also
investment inflows and outflows.
a. What rate of return should Oracle require on the
acquisition?
When there is a possibility of acquisition, the acquirer may plan
to increase the level of debt or decrease it after the merger
because at that moment of time the objectives of the target’s
finances is not ideal. The WACC reflects the company’s
business risk of the target. An intermediary for this can be
acquired from the unlevered beta of the target association’s
value or a normal unlevered beat for firm with comparable
business risk. The targets premerger unlevered beat should then
be re-levered to reflect what the acquirer expected to have as a
post-merger capital structure. To un-lever a company’s expected
beat, one should use the predominant tax rate and the debt to
equity ratio (D/E) of the company which relates to the beta
estimate. The equation is below;
ßu =ßL/[1+(1– T)D/E
Then, using the unlevered beta to estimate or normalize the
unlevered beta estimate if its utilizes numerous companies to
appraise the unlevered beta and the to re-lever the beta to the
new proposed debt to equity ratio. Using the below formula:
ß'L =ßu[1+(1– T)D/E
The rate of return that Oracle should require on the acquisition
is equal to the Sun Microsystem’s WACC which is equal to
12.05%. b. What base-case cash flows do you forecast?

The cash flow projections for the target company could
plausibly incorporate co-operative synergies or any cost savings
picked from the consolidation of the operations of the target
company into those of the acquirer. If the basis of the cash
flows does exclude any economic advantages an acquirer may
convey to a target, they are then introduced as a stand-alone
cash flows.
We then forecasted Sun Microsystem’s free cash flows for 5
years from year 2010 till year 2014. As what is shown in the
excel sheet Q3.1, the free cash flows are estimated which is
then increased from year 2010 till 2011, it then declines from
the year 2011 to year 2012 and then increased back again in
2012 till 2014. In Exhibit 14 the valuation of Sun Microsystems
was calculated using cash flows estimates. Sun Microsystems
operating income is calculated by EBIT using a tax rate of 35%
and that then indicates the NOPAT. Then the next step is that
we calculated the net working capital by adding the net
receivables and the inventory and other current assets then we
subtracted account payable and other current liabilities which is
taken from Exhibit 11.
The Net Working Capital (NWC) has an average of sales of
10.12% of net revenue which is found from Exhibit 14. In
addition, the PPE from Exhibit 14 was then used to calculate
Net PPE. Then this change in net working capital was calculated
by subtracting the Net PPE of 2009 from the Net PPE of 2010.
After finding the change in Net Working Capital, the Free Cash
Flows were then projected from years 2008 to 2014. To
calculate the Free Cash Flows (FCF), the change in Net
Working Capital and the change in capital expenditure was then
subtracted from the NOPAT. In Q3.3 the approach taken was the
multiples of comparable companies to get the terminal value
which is 7,480.
c. What is your estimate of terminal value?
To calculate the terminal value of the company, one must then

determine the perpetuity growth model and then the multiples of
comparable companies. In Q3.2, the terminal value of 4,815 was
calculated by dividing the perpetuity growth (444.35) by the
WACC of 12.05% minus the growth rate of 2.82%.d. What is
the enterprise value of Sun Microsystems? What is the equity
value?
Another method for valuation is the enterprise value for the
acquirer to maintain at the levels of consideration as it will
affect the bid price that a company will be willing to pay for the
target firm. When deciding on the bid price, the buyer (Oracle)
will perform an analysis of the future cash flows of the target
(Sun Microsystems) as a stand-alone business. The effects of
which will be if they have a higher enterprise value for the
target then they would raise the bid price and will still
undertake a positive net present value for investors. This stand-
alone value will give a benchmark for businesses and
shareholders to use when the decision making process occurs
for the organization takeover.
The enterprise value in the DCF with perpetuity growth was
calculated by adding the Net Present Value (NPV) of Free Cash
Flow (FCF) and the net present value of the terminal value. In
addition, to find the price per share of the equity value is was
calculated as (enterprise value – debt + cash) to then be divided
by the number of shares which are 739 which are found in
Exhibit 9. The result of which will be a price per share of $7.40.
Then the enterprise value which is found in the DCF with the
multiples was then calculated by adding the Net Present Value
(NPV) of Free Cash Flows (FCF) and the present value of the
terminal value. In addition, to find the price per share the equity
was calculated from (the enterprise value – debt + cash) to for it
then it to be divided by the number of shares which are 739
from Exhibit 9. The result will then be $9.44 price per
share.4.Conduct a compare companies or multiples analysis to
value Sun. What economic fundamentals are reflected in the
multiples?

The multiples used in valuation and the earnings of target
company must show consistency to obtain the best price. The
price to earnings multiple (price per share / earnings per share)
can be employed during the calculation. This method considers
estimating the equity and comparing it against the income. The
company in this scenario is evaluated basing on its free cash
flow. The revenue when used may mislead as it may illustrate
presumptions about the capital structure of a firm. Several
multiples which assimilate the capital structure of a firm have
therefore, been used. This would help to evaluate the company
in the same way that would be done by an acquirer. The price to
earnings multiple fails to amalgamate the sales multiples, cash
on hand, EBIT multiples, or EBITDA multiples of a firm.
Multiples of Comparable Companies
Comparable companies’ multiple is based on the assumption
that firms whose assets are the same trade their goods and
services at homogenous rates (Petitt & Ferris, 2013). Notably, a
proportion which assimilates certain values for example,
earnings would be same across companies in the same industry.
The valuation of a company can thus, be attained by taking into
account the figures of other firms in the form of an index which
are comparable in size as well as products that operate in the
same industry.
Sun is a firm which deals with hardware, business systems and
utilities, storage and software such as Java, Solaris, and
MySQL. A benchmark of companies which ae comparable to
Sun Microsystems must be performed to execute a comparison
analysis. See Exhibit 4 to gain a snapshot of the firms which
offer tangible and intangible goods.
The companies taken into consideration bearing in mind that
Sun is a hardware firm are Advanced, Micro Devices, Apple,
Dell, EMC, Hewlett-Packard (HP), Intel, International Business
Machines (IBM), and NetApp. These companies had to sieved
further to remain only with those who products and services are

similar to Sun. These companies are Apple, Dell, Hewlett-
Packard (HP), Intel, and International Business Machines
(IBM). Advanced Micro Devices, EMC, and NetApp offer
product lines and progression plans that are not the same as Sun
Microsystems.
The comparable companies’ levered betas reflect a median of
1.12 for the entire industry, and a levered beta of 1.73 for Sun
Microsystems (see Exhibit 9). Additionally, we figured out the
unlevered beta by computing the debt to equity (D/E) ratio. We
used a 35% tax rate (question 2), exhibiting a 9.35% median and
a 1.58 unlevered beta for the entire industry. Whilst Sun
Microsystems had a debt to equity (D/E) ratio of 25.44% and a
levered beta of 2.13 hence, it is considered to be rather higher
than the market. This indicates that the business is more
perilous compared to the industry in which it operates.
Therefore, this denotes the ideal ratio of debt to equity (D/E)
that Sun Microsystems must achieve. We also computed the cost
of equity by using the capital asset pricing model (CAPM). We
substituted a risk-free rate of 2.82% and a market premium rate
of 6% (as assumed in question 2). We further computed the debt
to capital ratio as well as equity to capital ratio in order to
attain the comparable companies’ weights of equity and debt
both. We achieved this by using the information provided in
Exhibit 9. We reasserted the optimum capital structure that
needs to be attained by Sun Microsystems in order to be
correspondent to the median of the industry. Each company’s
bond rating is mentioned in Exhibit 9, therefore, we took the
cost of debt from the corporate bond yields, which is provided
in Exhibit 10 (in conformance with the bond ratings for each
company).
Lastly, we calculated the WACC and reached a value of 9.50%
as the industry’s median and a value of 12.05% for Sun
Microsystems. It is therefore, evident that Sun Microsystems
has a cost of capital that is much higher than that of the
industry. This is reflected in the elevated rate of return that is
expected to be received on capitalizing in Sun Microsystems

(which denotes that firm is much distressful compared to the
other competing companies that operate in the industry).
Finally, we computed the multiples using EBIT, EBITDA as
well as Sales (provided in Exhibit 9).Multiples Analysis
EBIT Multiple
EBITDA Multiple
Sales Multiple
Sun Microsystems
-1.41
-13.15
1.72
Median
9.40
6.28
1.39
We integrated the multiples’ average values, as they are
essential in computing Sun Microsystems’ implied enterprise
value (EV).
For us to do the comparable companies analysis (CCA), we
needed to figure out the average price per share. We determined
that the foremost thing to do was use the average EBIT,
EBITDA and Sales average values for the former two years
(2007-2008) in order to form our information on documented
historical data. Since the accessible data was only for the
former two years, we decided to include the data for both years.
In the excel sheet Q.4, we included the detailed computations of
our calculations in order to find the average price per share,
after which we reached an outcome of $13.06 as the average
share price. Economic Fundamentals
To compute the terminal value, we took the U.S. treasury’s
earnings (for 10 years) and used it as the risk-free rate (which
was substituted as the growth rate). To compute the average
price per share needed for the comparable companies’ analysis

(CCA), we computed the implied enterprise value (EV) using
the averages of the multiples mentioned earlier. Knowing that
this comparable companies’ analysis (CCA) would be used to
set a benchmark for Sun Microsystems to be valued upon, we
must keep in mind that this benchmark might possibly result in
an inaccurate computation of the real worth of the company.
This would be due to the main fact that some companies are in a
considerably more fiscally sound and firm situation compared to
our target firm (Sun Microsystems), such as Apple or Dell.5.
Identify the synergies and conduct a sensitivity analysis to
estimate the effect of synergies on enterprise value.
The potential synergies were the integration charges of $1.1
billion whereby, $750 million were incurred in 2010 and the
remainder ($350 million) being incurred in 2011. A loss of $45
million in operating income was recorded. The loss is attributed
to clients’ loss and delay in purchases.
The cost-cutting that would be experienced by Sun after the
acquisition is staff reduction at around 20 to 25%. The company
will also realize reduction in selling, general, and
administrative expenses by 22 to 32%. Furthermore, licensing
income, new products, besides “integrated application to-disk”
service would result in an annual rise in operating profit by
$900 million. As had been previously assumed, these synergies
would be slowly increasing over a period of time that is,
between 2011 and 2013, attaining its $900 million full capacity
in 2013. See the spread sheet (Exhibit Q5.1) about the synergy
sources effects.
The spreadsheet (see questions 5.1, 5.2, and 5.3) shows how
Sun Microsystems are valued with synergies. Levered beta was
obtained from question two in the spreadsheet. Unlevered beta
was however, computed by conducting a subdivision of levered
beta by multiples by D / E where D is the weight of debt and E
is the weight of equity. The other figures which were obtained
from question 2 are equity weight, debt weight, market risk
premium, risk free rate, cost of equity, WACC, cost of debt, and
tax rate. The growth rate equates to risk free rate. This is

because there is a relationship between growth rate and risk-free
rate. Hence, any changes which occur in risk free rate is
correlated to changes in sustainable growth which is also
applicable to stand alone computed for question three above.
The figures for EBIT and EBIT multiple are obtained from
question four. Market value of equity and book value of debt
are obtained from exhibit nine in the spreadsheet. The market
value of equity and book value of debt are added together to
obtain the total value. Debt percentage is computed by dividing
the book value of debt over total figure. The synergies obtained
are used to find out the discounted free cash flow and free cash
flows. More information about the steps to be followed as
indicated below.
· EBIT and sales minus synergies were obtain from exhibit
fourteen. EBIT minus synergies equates to operating income.
Perpetuity growth for sales is computed by multiplying 2014
figure with 1+ growth rate.
· Initial loss in operating income is obtained from the textbook
page 679 which is $45 million. The loss is a result of customer
loss or / and deferred purchases.
· Integration charges are also obtained from page 679 leading to
a total value of $1.1 billion whereby, $750 million was incurred
in 2010 and the remaining in 2011.
· The operating profit is annually increasing by $900 million as
highlighted by Madison that the synergies would rise gradually
in three years beginning 2011. In 2011 therefore, the figure was
obtained by taking $900 million and dividing by three years
leading to $300 million. In 2012, $300 million was subtracted
from $900 million to confirm any increase. The figures for 2013
as well as 2014 are obtained from page 679 which is $900
million.
· EBIT with synergies was calculated by taking EBIT without
the synergies less loss in operating income less integration
charges then, add rise in net operating profit. The formula was
used for years 2010 to 2014.
· The taxes were computed by multiplying tax rate with EBIT.

2010 however, had negative EBIT leading to negative tax
values, making it wise to replace with zero because negative
taxes are not realistic.
· NOPAT is computed by taking EBIT with synergies less taxes.
Perpetuity growth is computed by multiplying NOPAT for last
year with 1+ the growth rate.
· Net PPE perpetuity growth and net working capital were
computed by multiplying 2014 figure with 1+ growth rate. PPE
and net working capital were gotten from question 3.1.
· The change in net working capital is New Year less prior year
which applies to 2010 to 2014 and is same for perpetuity
growth.
· Changes in capital expenditure are computed by taking 2010
PPE less 2009 PPE. PPE is seen as capital expenditure. This
step is also followed when computing perpetuity growth.
· Free cash flows for 2010 to 2014 and for perpetuity growth are
calculated by taking NOPAT less change in net working capital
less change in capital expenditure. The spreadsheet shows that
free cash flows are annually increasing.
· Discounted cash flow was computed by using both perpetuity
growths including the multiples (see question 5.2 and 5.3 in the
spreadsheet).Net present value was computed by using net
present value function which consists of free cash flows and
WACC from 2010 to 2014.
· The methods which can be utilized to compute terminal value
are perpetuity growth or comparable multiples. Discounted cash
flow with perpetuity growth shows that Sun will probably grow
throughout. The used growth rate (2.82%) equates to risk-fee
rate. The figure is same as terminal value in discounted cash
flow with perpetuity growth which was computed as 2014 free
cash flow divided by WACC less growth rate. Moreover,
discounted cash flow with multiple is computed as EBIT for
2014 multiplied by median multiple which is 9.40.
· Terminal value was divided by 1+ WACC power 5 showing the
years from 2010 to 2014 to find out terminal value net present
value. This applied to calculation of discounted cash flow with

multiple methods and perpetuity.
· To get enterprise value, free cash flow net present value was
added to terminal value net present value. Cash and debt were
gotten from exhibit eleven. Equity is computed as enterprise
value less debt adds cash. Total shares were gotten from exhibit
nine and price per share is gotten by taking equity and dividing
by shares outstanding.
· Both methods will lead to various prices per share. Discounted
cash flow with perpetuity growth will lead to price per share
which is $12.79 while discounted cash flow with price per share
of multiples will lead to $16.32.
· Specific synergies would take place if oracle acquires Sun;
· Oracle will use Sun’s Java programming to form several
applications.
· Sun’s MSQL will assist in adding widening customer base.
· Another added advantage is expansion of product lines as well
as risks.
· Research and development and sales teams of both companies
will be combined. The below table shows the sensitivity
analysis for the two approaches:
Stand-Alone Sensitivity Analysis:
Synergy Value Sensitivity Analysis:
The sensitivity analysis for the synergy values using the two
methods, perpetuity growth method (PGM) and the exit multiple
method (EMM) show a higher enterprise value then the stand-
alone valuation preformed.
Summary of Results:
Enterprise Value
Equity Value
Price per share
Stand-Alone (Base-Case) using the Perpetuity method

3,653 million
5,465 million
$7.40
Stand-Alone (Base- Case) using the Multiples method
5,161 million
6,973 million
$9.44
Synergy using the Perpetuity method
7,632 million
9,444 million
$12.79
Synergy using the Multiple method
10,238 million
12,050 million
$16.32
Comparable Company method
$13.06
Oracle’s offer price
$9.50
Sun Microsystem (Current Share Price)
$6.69
With respect to the above sensitivity analysis, it is notable that
the Stand-Alone by use of perpetuity method led to an
enterprise value of 3,653 million and an equity value of 5,465
million, eventually projecting a price of $7.40 per share which
is close to the price per share of Sun Microsystems. When the
multiple method for Stand-Alone was used we got $9.44 price
per share which has a difference of only $2.75 ($9.44-$6.69).

Therefore, the synergies valuation method was used to obtain
the accurate results of share price. The synergy using perpetuity
method which has an enterprise value of 7,632 million and an
equity value of 9,444 million resulted in a $12.79 price per
share. In addition, when using the multiple method for the
synergy, the price per share of $16.32 shows a major difference
between Sun Microsystems and Oracle’s offer price.6. If a
competing bidder appears, how high a price should Oracle be
willing to offer?
Sun Microsystems Implied Offer Price
Perpetuity Growth Method
Exit Multiple
Sun Microsystems Share Price
DCF using the Standalone Value
$7.40
$9.44
$8.42
DCF using the Synergy Value
$12.79
$16.32
$14.55
Average CCA
$13.06
Current Offer Price by Oracle
$9.50
Oracle is presently proposing the shares for a value of $9.50 per
share for Sun Microsystems. We have used the three different
approaches (as portrayed in the table above) in order to
ascertain the highest price that Oracle is inclined to pay. In the
DCF using the standalone value with perpetuity growth method

offered us a value of $7.40 per share. However, when we used
the exit multiple method, we got a value of $9.44 per share.
Conversely, in the DCF using the synergy value, the perpetuity
growth method offered us a value of $12.79 per share while the
exit multiple method offered us a value of $16.32 per share. The
two values are higher than the price offered by Oracle (which is
equivalent to $9.50 per share) in comparison to the DCF with
the standalone value.
Moreover, the values of each method, the perpetuity method and
the multiples method, were not accounted for autonomously
because of the challenges faced (as stated earlier in question 2).
Thus, in order to avert misrepresenting the real worth of Sun
Microsystems, we decided to take the average of the two
methods. Accordingly, to find out what the highest price Oracle
might propose to Sun Microsystems, values ranging from $8.42
to $14.55 was given (marking the lowest and highest prices that
Oracle may offer to Sun Microsystems). As portrayed, it is
evident that share price derived through the comparable
companies’ analysis (CCA) and the price offered by Oracle are
both contained within the suggested range (prices are $13.06
and $9.50 respectively).
All in all, we decided that the optimum price that should be
proposed by Oracle is $11.38. This value was computed by
finding the average of all the prices represented above along
with the amount that is offered by Oracle
((8.42+14.55+13.06+9.50)/4= $11.38).
7- What approaches and methods are used for valuation of
Mergers and Acquisitions; their pros and cons, role of synergies
in M&A valuation.
8- How the IT sector in general and software industry in
particular has grown in last ten years, who are the major
players, what are the key trends and future outlook. Please
highlight a recent Merger and Acquisition transaction (other
than Sun Microsystem) in the IT sector.

The growth in the IT sector can be looked at from various
dimensions. One of this dimension is the number of new users;
this can be looked at by looking at the number of internet users
for the last ten years, as at December 2008 the figure stood at
1.5 billion representing 23.5% of the world population while
currently the figure stands at above 55%. This has been pushed
by the availability of portable gadgets such mobile phones (Ray,
2018).
The other dimension is in terms of innovations and
technological changes, every system or even simple website has
to make provision for social media. Mobile phones have become
a substitute to computers and every company has to come up
with mobile friendly or compatible versions in order to cut a
niche in the market. Technology giants such as Samsung and
Apple have in the period engaged in fierce competitions with
new gadgets being released every year, the budget therefore has
changed with research and development cost going up. Oracle
has had to release new versions of the database from year 2007
when 11g was released to the current 18c.
The other dimensions is in terms of strategic alliances over the
years, in the last ten years giants have fallen and new giants
have come up, mergers and acquisitions have been common in
the past 10 years with one of the largest being Verizon
communications and Verizon wireless at a purchase price of
over $130 billion. One of the most recent acquisitions was by
Germany giant SAP where it acquired Qualtrics for $8 billion.
Qualtrics is market survey software maker and before the take
over the company had planned an IPO to raise $485 but the
takeover deal was a better deal for the owners and the
shareholders since the IPO would have taken the company
valuation to around $6 billion.
Over the last few years, Amazon, Apple, Google and Samsung
have dominated the market in various aspects such research,
funding, capitalization and revenues. Other major players in the
industry include Microsoft, Verizon and Facebook among
others. Looking forward mergers and acquisitions are bound to

increase with a common trend of venture capitalist coming in to
develop IT companies and selling them later. Looking at most
startups in the IT sector the main agenda is shifting from
competing with the giants to capturing the attention of the
giants for a possible acquisition or merger. In the near future
there will be cut throat competitions from the giants with an
effort to acquire small firms and form strategic alliances. I
foresee scenario where the market is bound to turn to an
oligopolistic market owing to the many mergers and
acquisitions.
Conclusion
It is recommended that Oracle acquires Sun Microsystems.
Oracle will be able to add new products such as MySQL, Java,
and Solaris to its portfolio. The acquisition will also weaken the
competition among the two companies even though the nature of
competition is indirect. The acquisition can however, create
cannibalization on Oracle’s software. Nevertheless, the
acquisition will grant Oracle an opportunity to increase its
market shares by dealing with consumers at the lower-end of the
market segment. On the other hand, the WACC of Sun
Microsystems is 12.05%, reflection that investing in the
company is appealing but comes with a high-risk level. The
methods which were used to arrive at the best price which
Oracle should offer Sun’s shares were discounted cash flow and
multiple valuation method. Discounted cash flow estimates the
stand-alone of Sun Microsystem by using WACC, equity value,
and enterprise value. As illustrated by the spreadsheet, the
enterprise value of $3,653 million and $5,465 million equity
value led to $7.40 share price. Notable, the difference between
the obtained share price and the original share price of $6.69
was little. The little difference is because the enterprise value
was calculated using terminal value, leading to conclusion, that
the values emanate from the future. In relation to discounted
cash flow, the investment is future and not present focused. The
final price per share was at a range $8.42 to $14.55. The
changes in the IT sector as well as software industry has been

assessed in terms of internet users, innovation, and strategic
alliances. Overall, the IT sector has realized immense growth
over the last decade. In conclusion, Oracle should Acquire Sun
Microsystems as the benefits outweigh the costs.
References
Brigham, E., & Ehrhardt, M. (2013). Financial management:
Theory and practice. Mason, Ohio: South-Western.
Comptia. (2018). IT industry outlook. Retrieved from
https://www.comptia.org/resources/it-industry-trends-analysis
Kumar, B. (2012). Mega mergers and acquisitions: Case studies
from key industries. Basingstoke: Palgrave Macmillan.
Nicalao, H. (2012). Sun acquisition by Oracle. New York, N.Y.:
Crypt Publishing.
Petitt, B., & Ferris, K. (2013). Valuation for mergers and
acquisitions. Upper Saddle River, N.J.: FT Press.

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