Page 52 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 25.h: Compare the discounted cash flow, comparable READING 25: MERGERS AND ACQUISITIONS
company, and comparable transaction analyses for valuing a target
company, including the advantages and disadvantages of each.
MODULE 25.3: TARGET COMPANY VALUATION

Discounted cash flow analysis:
Comparable company analysis:
Advantages:
• It is relatively easy to model any changes in target’s cash flow resulting Advantages:
from operating synergies or changes in cost structure. • Data for comparable companies is easy to access.
• Based on forecasts of fundamental conditions rather than current data. • Assumption that similar assets should have similar values is fundamentally sound.
• The model is easy to customize. • Estimates derived directly from the market than assumptions about the future.

Disadvantages: Disadvantages:
• Rapidly growing target may have negative FCFs to large • Is market always accurate?
CAPEX…value becomes negative? • You still need to determine takeover premium separately!
• Estimates of future cash flows and earnings are highly subject to error. • Difficult to incorporate merger synergies or changing capital structures into the analysis.
• Discount rate changes over time? Especially if terminal value is main • Historical data used to estimate a takeover premium may not be timely, and therefore
factor..
may not reflect current conditions in the M&A market.

Comparable transaction analysis

Advantages:
• As is uses data from actual transactions, no need to estimate a separate takeover premium.
• Directly from recent market prices for actual deals completed rather than from assumptions and estimates about the future.
• Use of actual prices from recent transactions reduces risk that the target’s shareholders could litigate against the its managers and board for mispricing the deal.
Disadvantages:
• Is market always accurate? If past transactions were mis-priced, this will spill over!
• Do we have enough comparable transactions to develop a reliable data set? If so, try M&A deals from other industries that are not similar enough!
• It is difficult to incorporate merger synergies or changing capital structures into the analysis.