Exam 7: Merger and Acquisition Cash Flow Valuation Basics

The discounted cash flow method for valuing a firm adjusts for differences in the magnitude and timing of cash flows and for risk.

Dose the deal still make sense to HP if the terminal period growth rate is 3 percent rather than 5 percent?

Net debt is defined as all of the firm's interest bearing debt less the value of cash and marketable securities.

Which one of the following factors is not considered in calculating the firm's cost of equity?

The weighted average cost of capital (WACC) is the broadest measure of the firm's cost of funds and represents the return that a firm must earn to induce investors to buy its common stock.

The Hunt for Elusive Synergy—@Home Acquires Excite Background Information Prior to @Home Network's merger with Excite for $6.7 billion, Excite's market value was about $3.5 billion. The new company combined the search engine capabilities of one of the best-known brands (at that time) on the Internet, Excite, with @Home's agreements with 21 cable companies worldwide. @Home gains access to the nearly 17 million households that are regular users of Excite. At the time, this transaction constituted the largest merger of Internet companies ever. At the time of the transaction, the combined firms, called Excite @Home, displayed a P/E ratio in excess of 260 based on the consensus earnings estimate of $0.21 per share. The firm's market value was $18.8 billion, 270 times sales. Investors had great expectations for the future performance of the combined firms, despite their lackluster profit performance since their inception. @Home provided interactive services to home and business users over its proprietary network, telephone company circuits, and through the cable companies' infrastructure. Subscribers paid $39.95 per month for the service. Assumptions • Excite is properly valued immediately prior to announcement of the transaction. • Annual customer service costs equal $50 per customer. • Annual customer revenue in the form of @Home access charges and ancillary services equals $500 per customer. This assumes that declining access charges in this highly competitive environment will be offset by increases in revenue from the sale of ancillary services. • None of the current Excite user households are current @Home customers. • New @Home customers acquired through Excite remain @Home customers in perpetuity. • @Home converts immediately 2 percent or 340,000 of the current 17 million Excite user households. • @Home's cost of capital is 20 percent during the growth period and drops to 10 percent during the slower, sustainable growth period; its combined federal and state tax rate is 40 percent. • Capital spending equals depreciation; current assets equal current liabilities. • FCFF from synergy increases by 15 percent annually for the next 10 years and 5 percent thereafter. Its cost of capital after the high-growth period drops to 10 percent. • The maximum purchase price @Home should pay for Excite equals Excite's current market price plus the synergy that results from the merger of the two businesses. -Use discounted cash flow (DCF) methods to determine if @Home overpaid for Excite.

The cost of equity is the minimum financial return required by investors to invest in stocks of comparable risk.

Creating a Global Luxury Hotel Chain Fairmont Hotels & Resorts Inc. announced on January 30, 2006, that it had agreed to be acquired by Kingdom Hotels and Colony Capital in an all-cash transaction valued at $45 per share. The transaction is valued at $3.9 billion, including assumed debt. The purchase price represents a 28% premium over Fairmont's closing price on November 4, 2005, the last day of trading when Kingdom and Colony expressed interest in Fairmont. The combination of Fairmont and Kingdom will create a luxury global hotel chain with 120 hotels in 24 countries. Discounted cash-flow analyses, including estimated synergies and terminal value, value the firm at $43.10 per share. The net asset value of Fairmont's real estate is believed to be $46.70 per share. -Is it reasonable to assume that the acquirer could actually be getting the operation for "free," since the value of the real estate per share is worth more than the purchase price per share? Explain your answer.