Page 47 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 25.i: Calculate free cash flows for a target company and estimate the
company’s intrinsic value based on discounted cash flow analysis. READING 25: MERGERS AND ACQUISITIONS

EXAMPLE: Valuing a merger target using discounted cash flow analysis: Goliath Manufacturing
is considering acquiring Slingshot Systems, a software development company. Goliath’s analysts MODULE 25.3: TARGET COMPANY VALUATION
have determined that a two-stage FCFF model is appropriate for their analysis, and have developed
the pro forma income statement and other financial data shown in the following table.
Calculate Slingshot’s free cash flows and estimate Slingshot’s value as of January 2017 using DCF analysis. The WACC for Slingshot is 9.75%. If the merger is completed,
Goliath plans to add debt to the capital structure that reduces the post-merger weighted average cost of capital, thus making the appropriate discount rate 9.50%.

556 (0.65)

2017 FCFF = $1,612 + 420 + 17 + [556 × (1 − 0.35)] − 1,104 − 384 = $922
2018 FCFF = $1,788 + 454 + 19 + [528 × (1 − 0.35)] − 1,192 − 415 = $997
Answer: 2019 FCFF = $1,997 + 494 + 22 + [502 × (1 − 0.35)] − 1,300 − 452 = $1,087
Steps 1 and 2 are complete. We are using a two-stage 2020 FCFF = $2,222 + 539 + 25 + [477 × (1 − 0.35)] − 1,417 − 493 = $1,186
FCF model and have computed the pro forma financials. 2021 FCFF = $2,466 + 587 + 27 + [453 × (1 − 0.35)] − 1,544 − 537 = $1,293
Step 3: Calculate free cash flows using the pro forma
data.