UM The Discounted Cash Flow and The US Market Analysis
1/ Analyze the way the discounted cash flow (DCF) analysis assists in the determination of the value of the target company and explain how using this method will allow the author to negotiate a reasonable price for the acquisition.
2/ Explain how the net present value (NPV) calculation, as part of the DCF, will the author to analyze strategic alternatives for the identified mergers and acquisitions activity.
Each section should have at least 300 words and at least two academic journals or scholarly articles as references.
Article 1
Environment Scan
Mergers and acquisitions often solidify and boost the competitive position of a company. However, if not properly done they can create various challenges. For a successful merger or acquisition, a favorable climate is required along with other critical success factors. The process of acquisition can be divided into two. The initial step of the process is the beginning of the negotiation process while the second step is the start of the implementation and the execution of the transaction.Both steps of the process are influenced by various factors.During the pre-transaction phase, various factors need to be taken into account. One factor is choosing the right partner. A wrong partner can lead to a strenuous negotiation process. Trust between the parties involved is another factor. Trust promotes smooth negotiations.During the post-transaction phase various factors need to be taken into account. The quality of the plan is one of the factors. A comprehensive and logical plan will promote success. The swiftness of the integration process is essential since it builds on trust. The execution of the plan needs to be of high quality to ensure success
Executive Summary
To get a reasonable price to pay for acquisitions of publicly traded firms comparable to your target company, various pricing benchmarks need to be accounted for. The intrinsic value of the company is one of them. The intrinsic value of a company is its most basic valuederived fromthe net present value of expected future cash flows while beingautonomousof any acquisitions. The market value is another pricing benchmark. The market value reflects the valuation of the company based on the market’s participants. Another price benchmark is the purchase price. This is the price that bidders anticipate to payso that thetarget shareholderscanaccept it. The synergy value is also important. This is the net present value that results from improvements made once the companies combine.
Merger premium is termed as the difference between theoffer priceof the targetand the market price before the transactionis announced(Corporate Finance Institute, 2021). To calculate the merger premium for your target company, one has to follow a process. One has to first identify both the present stock price and theprice paid per share of the target company. The merger premium is determined byfinding the difference betweenthe price paid per shareand thecurrent stock priceof the target company. The result is then divided by the target’s current stock price. The merger premium isarrived at usingthe share price 30 days before thefirststatementonacquisitionsincethe price of both companies is usually impacted in the days leadingup to a merger due to various macroeconomic factors and the execution of the merger process. This means that theacquiring firm’s shareholdersmayrealize a reductionin share value whilethe target firm’s shareholdersmayrealizea rise in share value withinthis time. This means that share prices may be inflated leading to wrong results.
The discounted cash flow (DCF) analysis and the net present value (NPV) calculation will be useful for the acquisition of mytarget company in various ways. TheDCF is usedin estimatingthepresent value of an investment dependingon itsprojectedfuture cash flows (Leybag, 2020). If the DCF value is higher than the current investment cost, the opportunity can lead to a positive return and vice versa. Companies often use the weighted average cost of capitalin finding thediscount rate since it accounts for the rate of return that shareholders expect. The NPV determines the current value of all future cash flows that a project generates. NPV is used in capital budgeting to determine the projects that are most likely to return maximum profits. While NPV is used to determine and compare external and internal investments, DCF is used tofind the time it would take to recoup thereturns. In other words, the NPV is an important tool in strengthening the DCF method.
Article 2
Executive Summary
According to Statista, the average deal or price paid for a merger in the communications sector was 151 million US dollars (Rudden, 2021). However, T-Mobile paid 26 billion dollars in the merger acquisition with Sprint. T-Mobile has increased their services and their prices as well as a result. The negotiation was between Softbank and T-Mobile because they owned 85% of Sprint. The deal was that Softbank would give T-Mobile 11 shares of Sprint for 1 of T-Mobile. The German company Deutsche Telekom would also receive stakes since it owns about 60% of T-Mobile. In a merger, every party must agree on a price. According to the textbook,
For a merger to proceed, both the target and the acquiring board of directors must approve the merger and put the question to a vote of the target's shareholders (and, in some cases, the shareholders of the acquiring firm as well). In a friendly takeover, the target board of directors supports the merger and negotiates with the potential acquirers. If the target board opposes the merger, the acquirer must go around the target board and appeal directly to the target shareholders, asking them to elect a new board to support the merger (Berk & Demarzo, 2014).
The process for calculating the premium would be by taking the original paid the price per share and subtracting it by the current stock price; The difference of the price would then be divided by the target company's stock which would give us the percentage. Yahoo mentioned the following,
Let's do the math. At 0.10256 T-Mobile shares for each Sprint share, the total amount of Sprint's shares outstanding will translate to 421.66 million T-Mobile shares. T-Mobile has 856.93 million shares outstanding, so that the deal will give Sprint control of approximately a third of the combined company. For $96.05 per share, each Sprint share is worth $9.85 (Yahoo, 2020). Essentially, Sprint investors had a significant opportunity to make money.
Banks like to use the DCF as a routine to value a business. A journal article mentioned, "companies are usefully viewed as generating streams of future cash flows to be benchmarked against investor return requirements" (Brotherson et al., 2014).
The DCF is also used to measure capital cost from the target company and some data from the financial markets. The DCF is also used to forecast buying shares when acquiring a company and for company budgeting. The model is used to capture analytic information. The NPV can be calculated by figuring out the expected cash flows of the acquiring company and figuring out the outcome of cost from both companies and knowing the amount that will be paid for the acquiring company (Brotherson et al., 2014).
Article 3
Executive Summary
As company’s merger the acquiring company has to determine what is a reasonable price to pay for the target company. There are multiple variables that go into determining the value of a company such as the discounted cash flow, net present value, and enterprise value. These values are derived from financial ratios such as P/E, EV/Sales, EV/EBITDA, and EBITDA/Sales. By comparing companies in the same markets can help determine what a company value is worth and also what an acquiring company may pay above the current market price for voting stock gaining control of the company. There are reasons to pay a premium for a merger but it is important to not over pay for a company and also ensure that initial capital invested will be earned back over the years after the merger.
Merger Premium Calculation Net 30 Days of Market Value for The Target Company.
The merger premium for a business merger is the price paid above the targets assessed market value which will translate to goodwill on the acquiring company’s balance sheet as an asset. To calculate the acquisition premium for DocuSign the acquiring company will determine what the deal price per share is then take DocuSigns current market price per share 30 days out from the announcement of the merger. When the deal price of the merger is subtracted from the current market price of the company the difference can be divided by the current market price to find the acquisition premium. The reason for using the current market price 30 days out from the announcement of the merger is the news of the merger will cause price movements in the companies’ stocks. The new market value of the stock would become an unrealistic price moved by speculation of investors and other market contributors. Whether the price of the stock rose creating a higher market value or declined creating a lower market value the price moved because of the announcement.
Discounted Cash Flow (DCF) Analysis and The Net Present Value (NPV) for The Acquisition of The Target Company.
The discount cash flow model is used to estimate the value of an investment based on its future cash flows. It is accomplished by using the weighted average cost of capital (WACC) of the business. With the expected cashflow estimated from the merger and the desired discount rate based on the opportunity of financing the merger it can be determined what the initial investment will produce in future profits from the merger. This will tie into the net present value for the discounted cash flow model which accounts for the time value of money. With the determination of what future profits of the business will make in the future the net present value determines what the business is worth today. Both the discount cash flow and net present value work closely together. As stated, Company valuation in mergers and acquisitions: How is discounted cash flow applied by leading practitioners?:
Brotherson, Eades, Harris, and Higgins (2013) find that the overwhelming majority of best practice companies use a DCF approach to evaluate an investment’s forecasted free cash flows against the weighted-average cost of capital (WACC). Since WACC is based on the individual sources of capital employed, it represents the required returns of investors based on their opportunity costs to invest elsewhere in financial markets. (Brotherson et al., 2015)
Once the opportunity cost of invested capital is determined through the DCF model it is then calculated what its current NPV is and this will help determine the acquisition price of the merger.