FM11_Ch_25_Tool_Kit - Chapter 25 Tool Kit for Mergers LBOs...

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8/5/2003 Chapter 25. Tool Kit for Mergers, LBOs, Divestitures, and Holding Companies APV ANALYSIS Generating Pro Forma Statements Long-term growth rate 6% Tax rate 40% Pro Forma Statements (figures in millions of dollars) 2005 2006 2007 2008 2009 . Net sales $105.0 $126.0 $151.0 $174.0 $191.0 . Costs of goods sold 80.0 94.0 113.0 130.0 142.0 . 10.0 12.0 13.0 15.0 16.0 . Depreciation 8.0 8.0 9.0 9.0 10.0 . EBIT 7.0 12.0 16.0 20.0 23.0 . Taxes on EBIT 2.8 4.8 6.4 8.0 9.2 . NOPAT 4.2 7.2 9.6 12.0 13.80 . Plus Depreciation 8.0 8.0 9.0 9.0 10.0 . Operating Cash Flow 12.2 15.2 18.6 21.0 23.8 . Less gross retention for growth 9.0 12.0 13.0 15.0 17.0 . Free Cash Flow 3.2 3.2 5.6 6.0 6.8 . Interest 6.0 5.0 4.0 4.0 4.0 . Interest Tax Shield 2.4 2.0 1.6 1.6 1.6 TUTWILER'S UNLEVERED COST OF EQUITY PROBLEM Calculate Tutwiler's unlevered cost of equity and WACC 7.0% Beta 1.2 MRP 5% 9% S $62.50 D $27.00 30.168% = + Beta * MRP = 7% + 1.2 * 5% = 13.00% In theory, merger analysis is quite simple. The acquiring firm performs an analysis to value the target company. The acquiring firm then seeks to buy the firm at preferably below that estimated value. Meanwhile, the target company would only want to accept the offer is the price exceeds its value if operated independently. In practice, however, the process of merger analysis is much more involved and raises some difficult issues. While many valuation techniques exist, we shall focus upon the two most common: the discounted cash flow and market multiple analysis. Regardless of the method used, it is crucial to recognize that the target company typically will not continue to operate as a separate entity, but rather it becomes part of the acquiring firm's portfolio of risky assets. This is significant because the operational changes that may occur will affect the value of the business and must be considered. In addition, it is important to remember that the goal of merger evaluation is to value the target company's equity, because the business is acquired from the company's owners, not its creditors. For that reason, our focus will be the value of equity, not total value. This process is very much like the process employed in Chapter 15 of the text to value stock. This method operates under the assumption that the intrinsic value of a firm is determined by the future cash flows that the firm will 'generate, discounted to the present. The value consists of two parts: the present value of the free cash flows and the present value of the tax savings due to the deductibility of interest payments. The first step in this approach is to create pro forma income statements for the target company as a subsidiary of the acquiring firm. The purpose of these pro forma statements is to project expected cash flows, because the incremental free cash flows generated by the merger are one of the key drivers of the valuation. The other driving factor of our valuation will be the discount rate we use. Post merger cash flow forecasts are by far the most important factor in a merger analysis.
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FM11_Ch_25_Tool_Kit - Chapter 25 Tool Kit for Mergers LBOs...

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