# Determine the value of target company on stand alone

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- Determine the value of target company on stand-alone basis and add the present value of tax benefits - Significant changes to the target company’s capital structure often occur due to business combinations - The changes in costs of debt capital would influence the WACC - To reflect the effect of the change in the target company’s capital structure on its business risks, it is necessary to re-estimate its beta . 7 | P a g e Forecast Free Cash Flows: Current Year Year 1 Year 2 Year 3 Turnover 100 000 115 000 132 250 152 088 - Cost of Sales (20 000) (23 000) (26 450) (30 418) Gross Profit 80 000 92 000 105 800 121 670 - Operating Expenses (10 000) (11 500) (13 225) (15 209) - Depreciation (10 000) (11 500) (13 225) (15 209) EBIT 60 000 69 000 79 350 91 252 - Tax (30%) (18 000) (20 700) (23 805) (27 376) Net Operating Profit After Tax (NOPAT) 42 000 48 300 55 545 63 879 + Depreciation 10 000 11 500 13 225 15 209 - CAPEX (20 000) (23 000) (26 450) (30 418) - ΔNOWC (7 500) (8 625) (9 919) (11 407) FCF 24 500 28 175 32 401 37 260 Terminal Value: 37 260 x (1 + 0.06) = R 987 390 (0.10 - 0.06) Value of the Company: CF 1 = 28 175 CF 2 = 32 401 CF 3 = 37 260 + 987 390 = 1 024 650 i = 10% NPV = ?? R 822 226.03 Difference in Scenarios: R 822 226.03 – R 360 000 = R 462 226

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- Re-estimating Beta This is a two phased process, it’s important that to get the levered beta that the unlevered beta is calculated first. Step 1 : Estimate the unlevered beta value Step 2 : Estimate the levered beta value 8 | P a g e B U = _ B L _ 1 + (1 – T) D / E Where: B U = the target company’s unlevered beta B L = target firms levered beta before business combination T = marginal tax rate D /E = debt/equity ratio before business combination B L = B U x 1 + ( 1 - T ) D / E Where: B U = unlevered beta calculated above B L = target firms levered beta after business combination D /E = debt/equity ratio after business combination Example (page 121) Let’s reconsider the cost of capital example of Meineken. Suppose that the management of WCB Ltd. considers the current capital structure of the company to be too conservative . They plan to increase the debt-equity ratio from its current value of 37.5%. The target capital structure after the business combination is as follows: Ordinary Share Capital 35% Preference Share Capital 15% Debentures 25% Long-term Loans 25% After the business combination has taken place, it is expected that WCB Ltd. can issue new debentures at a yield to maturity of 7%, while long-term loans can be raised at an interest rate of 11%.
- The third source of financial synergies is the value created by investing in profitable investment opportunities that were identified by the target company who didn’t have the available cash resources. - In this situation – calculate 1.) stand alone value 2.) add the net present value that would be created by the investment Incorporating the effect of changes in control that took place due to M&A Transaction - Sometimes enter into M&A due to the fact that the company isn’t managed correctly - By replacing the management with individuals who optimise the company – increase value - Value the transaction on the basis of what FCF will be generated if management is changed Free Cash Flow to Equity and Capital Cash Flow -

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