Mergers & Acquisions Deal

and

present

J ANUARY 26, 2013

THE F ORTNIGHTLY M & A DEAL

4. Determine Terminal Value It represents a significant portion of valuation of target. Given the challenges of projecting the target’s FCF indefinitely, a terminal value is used to quantify the remaining value of target after projection period. There are 2 methods used to calculate a company’s terminal value—exit multiple method (EMM) and the perpetuity growth method (PGM). The EMM calculates the remaining value of target after the projection period on the basis of a multiple of the target’s terminal year EBITDA (or EBIT). The PGM calculates terminal value by treating target’s terminal year FCF as perpetuity growing at an assumed rate. 5. Calculate Present Value and Determine Valuation The target’s projected free cash flows and terminal value is discounted using WACC are summed up to arrive at enterprise value. This is done by multiplying FCF for each year in the projection period, as well as the terminal value, by its respective discount factor. Advantages of the DCF method 1. Cash flow-based Reflects value of projected FCF, which represents a more fundamental approach to valuation than using multiples-based methodologies 2. Free of market imperfections Insulated from market distortions such as bubbles & distressed periods 3. Independent of external distortions Does not rely entirely upon truly comparable companies or transactions, which may or may not exist, to frame valuation; DCF is crucial when there are limited or no “pure play” public comparables for company being valued 4. Sensitivity Analysis Amenable to multiple financial performance scenarios, for e.g. changing growth rates, margins, capex, working capital efficiency Disadvantages of the DCF method 1. Dependence on financial projections Accurate forecasting of financial performance is challenging, especially as the projection period lengthens 2. Sensitivity to assumptions Relatively small changes in key assumptions, such as growth...