Firms will often cite a large number of reasons for

This preview shows page 11 - 13 out of 28 pages.

Firms will often cite a large number of reasons for merging. For example, in the 2004 Sprint–Nextel merger, the companies stated in the merger announcement that they expected a $12 billion net present value, primarily due to the following synergies: Saving network operating expenses by reducing the number of cell sites and switches. Reducing overall capital expenditures by extending Sprint’s current deployment of next-generation technology to the combined customer base. Migrating Nextel’s telecommunications traffic to Sprint’s long-haul infrastructure. Optimizing consumer care, billing, and IT costs by consolidating operations. Reducing combined sales and marketing costs. Lowering overall general and administrative costs. Reducing network capital expense after the merger by building a true IP-based multimedia network. Notice that most of these synergies come in the form of operating and capital costs savings, so economies of scale and reductions in capital needs were the main value drivers. Avoiding Mistakes Evaluating the benefit of a potential acquisition is more difficult than a standard capital budgeting analysis because so much of the value can come from intangible, or otherwise difficult to quantify, benefits. Consequently, there is a great deal of room for error. Here are some general rules that should be remembered: 1. Do Not Ignore Market Values . There is no point to, and little gain from, estimat- ing the value of a publicly traded firm when that value can be directly observed.
Image of page 11

Subscribe to view the full document.

12 The current market value represents a consensus opinion of investors concerning the firm’s value (under existing management). Use this value as a starting point. If the firm is not publicly held, then the place to start is with similar firms that are publicly held. 2. Estimate Only Incremental Cash Flows . It is important to estimate the incremen- tal cash flows that will result from the acquisition. Only incremental cash flows from an acquisition will add value to the acquiring firm. Acquisition analysis should thus focus only on the newly created, incremental cash flows from the proposed acquisition. 3. Use the Correct Discount Rate . The discount rate should be the required rate of return for the incremental cash flows associated with the acquisition. It should reflect the risk associated with the use of funds, not the source. In particular, if Firm A is acquiring Firm B, then Firm A’s cost of capital is not particularly rel- evant. Firm B’s cost of capital is a much more appropriate discount rate because it reflects the risk of Firm B’s cash flows. 4. Be Aware of Transaction Costs . An acquisition may involve substantial (and sometimes astounding) transaction costs. These will include fees to investment bankers, legal fees, and disclosure requirements.
Image of page 12
Image of page 13
You've reached the end of this preview.
  • Spring '12
  • Scott
  • Firm, Firm B

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern