Page 43 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 33.e: Explain cash flow estimation issues READING 33: PRIVATE COMPANYVALUATION
related to private companies and adjustments
required to estimate normalized earnings.
MODULE 33.2: INCOME-BASED VALUATION

1. Because the market rate is $1,500,000 less, SG&A expenses should be reduced by $1,500,000 to reflect a normalized compensation
expense.
2. Because the market lease rate is $30,000 higher than reported, SG&A expenses should be increased by $30,000 to reflect a
normalized lease rate.
3. Because the office building is non-core, SG&A expenses should be reduced by $150,000, and depreciation expense should be reduced
by $25,000.
4. Because the capital structure is non-optimal, the analyst will drop interest expense from the calculation of operating income under the
assumption that the capital structure will be changed if the firm is acquired. As we will see, interest expense is added back when
calculating free cash flow to the firm.

Strategic and Nonstrategic (financial) Buyers
In a strategic transaction, valuation of the firm is based in part on the perceived synergies with the acquirer’s other assets (you
need to incorporate any synergies as an increase in revenues or as a reduction in costs). A financial transaction assumes no
synergies, as when one firm buys another in a dissimilar industry.

EXAMPLE: Incorporating synergies: An analyst is valuing a firm for two different buyers. Buyer A is a firm, in the same industry as the
target firm, which expects to reduce costs at the target firm by eliminating redundancies. Buyer B is a firm in another industry. Calculate the
normalized EBITDA for each buyer given the information below.

Both strategic (Buyer A) and nonstrategic (Buyer B) buyers will attempt to reduce
executive compensation to market levels.

So the adjustment for both buyers to generate normalized EBITDA is $4,800,000 +
($900,000 − $600,000) = $5,100,000.

However, only Buyer A will be able to realize synergistic savings of $400,000
($8,000,000 − $7,600,000).

So normalized EBITDA for Buyer A is $5,500,000 and for Buyer B it is $5,100,000.