Prepared by: Matt H.

Evans, CPA, CMA, CFM

Part 2 of this course continues with an overview of the
merer and ac!uisition process, inc"udin the va"uation
process, post merer interation and anti#ta$eover
defenses. %he purpose of this course is to ive the user a
so"id understandin of how merers and ac!uisitions
wor$. %his course dea"s with advanced concepts in
va"uation. %herefore, the user shou"d have an
understandin of cost of capita", forecastin, and va"ue
based manaement before ta$in this course. %his
course is recommended for 2 hours of Continuin
Professiona" Education. &n order to receive credit, you wi""
need to pass a mu"tip"e choice e'am which is
administered over the internet at www.e'infm.com(trainin
Pub"ished )une 2***

E'ce""ence in Financia" Manaement

Valuation Concepts & Standards
As indicated in Part + of this ,hort Course, a ma-or cha""ene within the merer and
ac!uisition process is due di"ience. .ne of the more critica" e"ements within due di"ience is
va"uation of the %aret Company.
/e need to assin a va"ue or more specifica""y a rane of va"ues to the %aret Company so
that we can uide the merer and ac!uisition process. /e need answers to severa"
!uestions: How much shou"d we pay for the taret company, how much is the taret worth,
how does this compare to the current mar$et va"ue of the taret company, etc.0
&t shou"d be noted that the va"uation process is not intended to estab"ish a se""in price for the
%aret Company. &n the end, the price paid is whatever the buyer and the se""er aree to.
%he va"uation decision is treated as a capita" budetin decision usin the 1iscounted Cash
F"ow 21CF3 Mode". %he reason why we use the 1CF Mode" for va"uation is because:
1iscounted Cash F"ow captures a"" of the e"ements important to va"uation.
1iscounted Cash F"ow is based on the concept that investments add va"ue when returns
e'ceed the cost of capita".
1iscounted Cash F"ow has support from both research and within the mar$etp"ace.
%he va"uation computation inc"udes the fo""owin steps:
+. 1iscountin the future e'pected cash f"ows over a forecast period.
2. Addin a termina" va"ue to cover the period beyond the forecast period.
4. Addin investment income, e'cess cash, and other non#operatin assets at their present
va"ues.
5. ,ubtractin out the fair mar$et va"ues of debt so that we can arrive at the va"ue of e!uity.
6efore we et into the va"uation computation, we need to as$: /hat are we tryin to va"ue0
1o we want to assin va"ue to the e!uity of the taret0 1o we va"ue the %aret Company on
a "on#term basis or a short#term basis0 For e'amp"e, the va"uation of a company e'pected
to be "i!uidated is different from the va"uation of a oin concern.
Most merers and ac!uisitions are directed at ac!uirin the e!uity of the %aret Company.
However, when you ac!uire ownership 2e!uity3 of the %aret Company, you wi"" assume the
outstandin "iabi"ities of the taret. %his wi"" increase the purchase price of the %aret
Company.

Chapter
4
E'amp"e + # 1etermine Purchase Price of %aret Company
Ettco has areed to ac!uire +**7 ownership 2e!uity3 of Fu"ton for 8 +**
mi""ion. Fu"ton has 8 49 mi""ion of "iabi"ities outstandin.
Amount Paid to Ac!uire Fu"ton 8 +** mi""ion
.utstandin :iabi"ities Assumed 49 mi""ion
%ota" Purchase Price 8 +49 mi""ion
;ey Point Ettco has ac!uired Fu"ton based on the assumption that
Fu"ton<s business wi"" enerate a =et Present >a"ue of 8 +49 mi""ion.
For pub"ic"y traded companies, we can et some idea of the economic va"ue of a company by
"oo$in at the stoc$ mar$et price. %he va"ue of the e!uity p"us the va"ue of the debt is the tota"
mar$et va"ue of the %aret Company.
E'amp"e 2 # %ota" Mar$et >a"ue of %aret Company
?eferrin bac$ to E'amp"e +, assume Fu"ton has 2,9**,*** shares of stoc$
outstandin. Fu"ton<s stoc$ is se""in for 8 @*.** per share and the fair
mar$et va"ue of Fu"ton<s debt is 8 5* mi""ion.
Mar$et >a"ue of ,toc$ 22,9**,*** ' 8 @*.**3 8 +9* mi""ion
Mar$et >a"ue of 1ebt 5* mi""ion
%ota" Mar$et >a"ue of Fu"ton 8 +A* mi""ion
A word of caution about re"yin on mar$et va"ues within the stoc$ mar$etB stoc$s rare"y trade
in "are b"oc$s simi"ar to merer and ac!uisition transactions. Conse!uent"y, if the pub"ic"y
traded taret has "ow tradin vo"umes, then prevai"in mar$et prices are not a re"iab"e
indicator of va"ue.
Income Streams
.ne of the di"emmas within the merer and ac!uisition process is se"ection of income
streams for discountin. &ncome streams inc"ude Earnins, Earnins 6efore &nterest C %a'es
2E6&%3, Earnins 6efore &nterest %a'es 1epreciation C AmortiDation 2E6&%1A3, .peratin
Cash F"ow, Free Cash F"ow, Economic >a"ue Added 2E>A3, etc.
&n financia" manaement, we reconiDe that va"ue occurs when there is a positive ap
between return on invested capita" "ess cost of capita". Additiona""y, we reconiDe that
earnins can be -udmenta", sub-ect to accountin ru"es and distortions. >a"uations need to
be rooted in Ehard numbers.E %herefore, va"uations tend to focus on cash f"ows, such as
operatin cash f"ows and free cash f"ows over a pro-ected forecast period.
2
ree Cas! lo"
.ne of the more re"iab"e cash f"ows for va"uations is Free Cash F"ow 2FCF3. FCF accounts
for future investments that must be made to sustain cash f"ow. Compare this to E6&%1A,
which inores any and a"" future re!uired investments. Conse!uent"y, FCF is considerab"y
more re"iab"e than E6&%1A and other earnins#based income streams. %he basic formu"a for
ca"cu"atin Free Cash F"ow 2FCF3 is:
FCF F E6&% 2+ # t 3 G 1epreciation # Capita" E'penditures G or # =et /or$in Capita"
2 + # t 3 is the after ta' percent, used to convert E6&% to after ta'es.
1epreciation is added bac$ since this is a non#cash f"ow item within E6&%
Capita" E'penditures represent investments that must be made to rep"enish assets and
enerate future revenues and cash f"ows.
=et /or$in Capita" re!uirements may be invo"ved when we ma$e capita" investments. At
the end of a capita" pro-ect, the chane to wor$in capita" may et reversed.
E'amp"e 4 # Ca"cu"ation of Free Cash F"ow
E6&% 8 5**
:ess Cash %a'es 2+4*3
.peratin Profits after ta'es 2H*
Add 6ac$ 1epreciation H9
Iross Cash F"ow 459
Chane in /or$in Capita" 52
Capita" E'penditures 22H*3
.peratin Free Cash F"ow ++H
Cash from =on .peratin Assets J +*
Free Cash F"ow 8 +2H
J &nvestments in Mar$etab"e ,ecurities
&n addition to payin out cash for capita" investments, we may find that we have some fi'ed
ob"iations. A different approach to ca"cu"atin Free Cash F"ow is:
FCF F After %a' .peratin %a' Cash F"ow # &nterest 2 + # t 3 # P1 # ?P # ?1 # E
P1: Preferred ,toc$ 1ividends
?P: E'pected ?edemption of Preferred ,toc$
?1: E'pected ?edemption of 1ebt
E: E'penditures re!uired to sustain cash f"ows
#
E'amp"e 5 # Ca"cu"ation of Free Cash F"ow
%he fo""owin pro-ections have been made for the year 2**9:
.peratin Cash F"ow after ta'es are estimated as 8 +A*,***
&nterest payments on debt are e'pected to be 8 +*,***
?edemption payments on debt are e'pected to be 8 5*,***
=ew investments are e'pected to be 8 2*,***
%he marina" ta' rate is e'pected to be 4*7
After %a' .peratin Cash F"ow 8 +A*,***
:ess After %a' 1epreciation 28+*,*** ' 2+ # .4*33 2 H,***3
1ebt ?edemption Payment 25*,***3
=ew &nvestments 22*,***3
Free Cash F"ow 8 +24,***
$iscount %ate
=ow that we have some idea of our income stream for va"uin the %aret Company, we need
to determine the discount rate for ca"cu"atin present va"ues. %he discount rate used shou"d
match the ris$ associated with the free cash f"ows. &f the e'pected free cash f"ows are hih"y
uncertain, this increases ris$ and increases the discount rate. %he ris$ier the investment, the
hiher the discount rate and vice versa. Another way of "oo$in at this is to as$ yourse"f #
/hat rate of return do investors re!uire for a simi"ar type of investment0
,ince va"uation of the taret<s e!uity is often the ob-ective within the va"uation process, it is
usefu" to focus our attention on the EtaretedE capita" structure of the %aret Company. A
review of comparab"e firms in the mar$etp"ace can he"p ascertain tareted capita" structures.
6ased on this capita" structure, we can ca"cu"ate an overa"" weihted averae cost of capita"
2/ACC3. %he /ACC wi"" serve as our base for discountin the free cash f"ows of the %aret
Company.
&asic Applications
>a"uin a taret company is more or "ess an e'tension of what we $now from capita"
budetin. &f the =et Present >a"ue of the investment is positive, we add va"ue throuh a
merer and ac!uisition.
E'amp"e 9 # Ca"cu"ate =et Present >a"ue
,hannon Corporation is considerin ac!uirin 1a"ton Company for 8
+**,*** in cash. 1a"ton<s cost of capita" is +@7. 6ased on mar$et ana"ysis,
a tareted cost of capita" for 1a"ton is +27. ,hannon has estimated that
1a"ton can enerate 8 A,*** of free cash f"ows over the ne't +2 years.
Ksin =et Present >a"ue, shou"d ,hannon ac!uire 1a"ton0
4
&nitia" Cash .ut"ay 8 2+**,***3
FCF of 8 A,*** ' @.+A55 J 99,H9*
=et Present >a"ue 8 2 55,29*3
J present va"ue factor of annuity at +27, +2 years.
6ased on =P>, ,hannon shou"d not ac!uire 1a"ton since there is a
neative =P> for this investment.
/e a"so need to remember that some ac!uisitions are re"ated to physica" assets and some
assets may be so"d after the merer.
E'amp"e @ # Ca"cu"ate =et Present >a"ue
6ishop Company has decided to se"" its business for a sa"es price of 8
9*,***. 6ishop<s 6a"ance ,heet disc"oses the fo""owin:
Cash 8 4,***
Accounts ?eceivab"e H,***
&nventory +2,***
E!uipment # 1ye ++9,***
E!uipment # Cuttin 49,***
E!uipment # Pac$in 4*,***
%ota" Assets 8 2*2,***
:iabi"ities L*,***
E!uity +22,***
%ota" :iab C E!uity 8 2*2,***
A""man Company is interested in ac!uirin two assets # 1ye and Cuttin
E!uipment. A""man intends to se"" a"" remainin assets for 8 49,***. A""man
estimates that tota" future free cash f"ows from the dye and cuttin
e!uipment wi"" be 8 2@,*** per year over the ne't L years. %he cost of
capita" is +*7 for the associated free cash f"ows. &norin ta'es, shou"d
A""man ac!uire 6ishop for 8 9*,***0
Amount Paid to 6ishop 8 29*,***3
Amount 1ue Creditors 2L*,***3
:ess Cash on Hand 4,***
:ess Cash from ,a"e of Assets 49,***
%ota" &nitia" Cash .ut"ay 8 2A2,***3
Present >a"ue of FCF<s for L years
at +*7 # 8 2@,*** ' 9.445A +4L,H*H
=et Present >a"ue 2=P>3 8 5@,H*H
6ased on =P>, A""man shou"d ac!uire 6ishop for 8 9*,*** since there is a
positive =P> of 8 5@,H*H.
'
A so"id estimation of incrementa" chanes to cash f"ow is critica" to the va"uation process.
6ecause of the variabi"ity of what can happen in the future, it is usefu" to run cash f"ow
estimates throuh sensitivity ana"ysis, usin different variab"es to assess Ewhat ifE type
ana"ysis. Probabi"ity distributions are used to assin va"ues to various variab"es. ,imu"ation
ana"ysis can be used to eva"uate estimates that are more comp"icated.
Valuation Standards
6efore we et into the va"uation ca"cu"ation, we shou"d reconiDe va"uation standards. Most
of us are reasonab"y aware that Ienera""y Accepted Accountin Princip"es 2IAAP3 are used
as standards to uide the preparation of financia" statements. /hen we ca"cu"ate the va"ue
2appraisa"3 of a company, there is a set of standards $nown as EKniform ,tandards of
Professiona" Appraisa" PracticeE or K,AAP. K,AAP<s are issued by the Appraisa"s ,tandards
6oard. Here are some e'amp"es:
%o avoid misuse or misunderstandin when 1iscounted Cash F"ow 21CF3 ana"ysis is
used in an appraisa" assinment to estimate mar$et va"ue, it is the responsibi"ity of
the appraiser to ensure that the contro""in input is consistent with mar$et evidence
and prevai"in attitudes. Mar$et va"ue 1CF ana"ysis shou"d be supported by mar$et
derived data, and the assumptions shou"d be both mar$et and property specific.
Mar$et va"ue 1CF ana"ysis is intended to ref"ect the e'pectations and perceptions of
mar$et participants a"on with avai"ab"e factua" data.
&n deve"opin a rea" property appraisa", an appraiser must: 2a3 be aware of,
understand, and correct"y emp"oy those reconiDed methods and techni!ues that are
necessary to produce a creditab"e appraisa"B 2b3 not commit a substantia" error of
omission or co#omission that sinificant"y affects an appraisa"B 2c3 not render appraisa"
services in a care"ess or ne"ient manner, such as a series of errors that considered
individua""y may not sinificant"y affect the resu"t of an appraisa", but which when
considered in areate wou"d be mis"eadin.
Another area that can create some confusion is the definition of mar$et va"ue. %his is
particu"ar"y important where the %aret Company is private 2no mar$et e'ists3. Peop"e
invo"ved in the va"uation process sometimes refer to &?, ?evenue ?u"in 9A#@* which
defines mar$et va"ue as:
%he price at which the property cou"d chane hands between a wi""in buyer and a
wi""in se""er when the former is not under any compu"sion to buy and the "atter is not
under any compu"sion to se"", both parties havin reasonab"e $now"ede of re"evant
facts.
A fina" point about va"uation standards concerns professiona" certification. %wo prorams
direct"y re"ated to va"uations are Certified >a"uation Ana"yst 2C>A3 and Accredited in 6usiness
>a"uations 2A6>3. %he C>A is administered by the =ationa" Association of C>A<s
2www.nacva.com3 and the A6> is administered by the American &nstitute of Certified Pub"ic
Accountants 2A&CPA # www.aicpa.or3. En"istin peop"e who carry these professiona"
desinations is hih"y recommended.
(
)!e Valuation Process
/e have set the stae for va"uin the %aret Company. %he overa"" process is centered
around free cash f"ows and the 1iscounted Cash F"ow 21CF3 Mode". /e wi"" now focus on
the finer points in ca"cu"atin the va"uation. &n the boo$ >a"uation: Measurin and Manain
the >a"ue of Companies, the authors %om Cop"and, %im ;o""er, and )ac$ Murrin out"ine five
steps for va"uin a company:
+. Historica" Ana"ysis: A detai" ana"ysis of past performance, inc"udin a determination of
what drives performance. ,evera" financia" ca"cu"ations need to be made, such as free
cash f"ows, return on capita", etc. ?atio ana"ysis and benchmar$in are a"so used to
identify trends that wi"" carry forward into the future.
2. Performance Forecast: &t wi"" be necessary to estimate the future financia" performance of
the taret company. %his re!uires a c"ear understandin of what drives performance and
what syneries are e'pected from the merer.
4. Estimate Cost of Capita": /e need to determine a weihed averae cost of capita" for
discountin the free cash f"ows.
5. Estimate %ermina" >a"ue: /e wi"" add a termina" va"ue to our forecast period to account
for the time beyond the forecast period.
9. %est C &nterpret ?esu"ts: Fina""y, once the va"uation is ca"cu"ated, the resu"ts shou"d be
tested aainst independent sources, revised, fina"iDed, and presented to senior
manaement.
inancial Anal*sis
/e start the va"uation process with a comp"ete ana"ysis of historica" performance. %he
va"uation process must be rooted in factua" evidence. %his historica" evidence inc"udes at
"east the "ast five years 2preferab"y the "ast ten years3 of financia" statements for the %aret
Company. 6y ana"yDin past performance, we can deve"op a synopsis or conc"usion about
the %aret Company<s future e'pected performance. &t is a"so important to ain an
understandin of how the %aret Company enerates and invests its cash f"ows.
.ne obvious p"ace to start is to assess how the merer wi"" affect earnins. P ( E ?atios 2price
to earnins per share3 can be used as a rouh indicator for assessin the impact on
earnins. %he hiher the P ( E ?atio of the ac!uirin firm compared to the taret company,
the reater the increase in Earnins per ,hare 2EP,3 to the ac!uirin firm. 1i"ution of EP,
occurs when the P ( E ?atio Paid for the taret e'ceeds the P ( E ?atio of the ac!uirin
company. %he siDe of the taret<s earnins is a"so importantB the "arer the taret<s earnins
are re"ative to the ac!uirer, the reater the increase to EP, for the combined company. %he
fo""owin e'amp"es wi"" i""ustrate these points.
Chapter
'
7
E'amp"e H # Ca"cu"ate Combined EP,
Ireer Company has p"ans to ac!uire Ho"t Company by e'chanin stoc$.
Ireer wi"" issue +.9 shares of its stoc$ for each share of Ho"t. Financia"
information for the two companies is as fo""ows:
Ireer Ho"t
=et &ncome 8 5**,*** 8 +**,***
,hares .utstandin 2**,*** 29,***
Earnins per ,hare 8 2.** 8 5.**
Mar$et Price of ,toc$ 8 5*.** 8 5L.**
Ireer e'pects the P ( E ?atio for the combined company to be +9.
Combined EP, F 28 5**,*** G 8 +**,***3 ( 22**,*** shares G 229,*** '
+.933 F 8 9**,*** ( 24H,9** F 8 2.++
E'pected P ( E ?atio ' +9
E'pected Price of ,toc$ 8 4+.@9

6efore we move to our ne't e'amp"e, we shou"d e'p"ain e'chane ratios. %he e'chane ratio
is the number of shares offered by the ac!uirin company in re"ation to each share of the
%aret Company. /e can ca"cu"ate the e'chane ratio as:
Price Offered by Acquiring Firm / Market Price of Acquiring Firm
E'amp"e L # 1etermine 1i"ution of EP,
?omer Company wi"" ac!uire a"" of the outstandin stoc$ of 1ayton
Company throuh an e'chane of stoc$. ?omer is offerin 8 @9.** per
share for 1ayton. Financia" information for the two companies is as fo""ows:
?omer 1ayton
=et &ncome 8 9*,*** 8 +*,***
,hares .utstandin 9,*** 2,***
Earnins per ,hare 8 +*.** 8 9.**
Mar$et Price of ,toc$ 8 +9*.**
P ( E ?atio +9
2+3 Ca"cu"ate shares to be issued by ?omer: 8 @9 ( 8 +9* ' 2,*** shares F
L@H shares to be issued.
223 Ca"cu"ate Combined EP,: 28 9*,*** G 8 +*,***3 ( 29,*** G L@H3 F 8 +*.24
243 Ca"cu"ate P ( E ?atio Paid: Price .ffered ( EP, of %aret or 8 @9.** ( 8
9.** F +4
253 Compare P ( E ?atio Paid to current P ( E ?atio: ,ince +4 is "ess than the
current ratio of +9, there shou"d be no di"ution of EP, for the combined
company.
293 Ca"cu"ate ma'imum price before di"ution of EP,: +9 F price ( 8 9.** or 8
H9.** per share. 8 H9.** is the ma'imum price that ?omer shou"d pay
before EP, are di"uted.
+
&t is important to note that we do not want to et over"y pre#occupied with earnins when it
comes to financia" ana"ysis. Most of our attention shou"d be directed at drivers of va"ue, such
as return on capita". For e'amp"e, free cash f"ow and economic va"ue added are much more
important drivers of va"ue than EP, and P ( E ?atios. %herefore, our financia" ana"ysis shou"d
determine how does the taret company create va"ue # does it come from e!uity, what capita"
structure is used, etc.0 &n order to answer these !uestions, we need to:
+. Ca"cu"ate va"ue drivers, such as free cash f"ow.
2. Ana"yDe the resu"ts, "oo$in for trends and comparin the resu"ts to other companies.
4. :oo$in bac$ historica""y in order to ascertain a Enorma"E "eve" of performance.
5. Ana"yDin the detai"s to uncover how the %aret Company creates va"ue and notin what
chanes have ta$en p"ace.
Value $ri,ers
%hree core financia" drivers of va"ue are:
+. ?eturn on &nvested Capita" 2=.PA% ( &nvested Capita"3
2. Free Cash F"ows
4. Economic >a"ue Added 2=.PA% # Cost of Capita"3
=.PA%: =et .peratin Profits After %a'es
A va"ue driver can represent any variab"e that affects the va"ue of the company, ranin from
reat customer service to innovative products. .nce we have identified these va"ue drivers,
we ain a so"id understandin about how the company functions. %he $ey is to have these
va"ue drivers fit between the %aret Company and the Ac!uirin Company. /hen we have a
ood fit or a"inment, manaement wi"" have the abi"ity to inf"uence these drivers and
enerate hiher va"ues.
&n the boo$ >a"uation: Measurin and Manain the >a"ue of Companies, the authors brea$
down va"ue drivers into three cateories:
%ype of >a"ue 1river Manaement<s Abi"ity to &nf"uence
:eve" + # Ieneric :ow
:eve" 2 # 6usiness Knits Moderate
:eve" 4 # .peratin Hih
For e'amp"e, sa"es revenue is a eneric va"ue driver 2"eve" +3, customer mi' wou"d be a
business unit va"ue driver 2"eve" 23, and customers retained wou"d be an operatin va"ue
driver 2"eve" 43. ,ince va"ue drivers are inter#re"ated and since manaement wi"" have more
inf"uence over "eve" 4 drivers, the $ey is to ascertain if the merer wi"" ive manaement more
or "ess inf"uence over the operatin va"ue driver. &f yes, then a merer and ac!uisition cou"d
"ead to revenue or e'pense syneries. 6e advised that you shou"d not wor$ in reverse orderB
i.e. from "eve" + down to "eve" 4. For e'amp"e, an increase in sa"es pricin wi"" add more va"ue
to "eve" +, but in the "on#run you wi"" hurt customers retained 2"eve" 43 and thus, you may
end#up destroyin va"ue.
-
.nce we have identified va"ue drivers, we can deve"op a strateic view of the %aret
Company. %his strateic view a"on with drivers of va"ue must be considered in ma$in a
performance forecast of the %aret Company. /e want to $now how wi"" the %aret Company
perform in the future. &n order to answer this !uestion, we must have a c"ear understandin of
the advantaes that the %aret Company has in re"ation to the competition. %hese
competitive advantaes can inc"ude thins "i$e customer mi', brand names, mar$et share,
business processes, barriers to competition, etc. An understandin of competitive
advantaes wi"" ive us insihts into future e'pected rowth for the %aret Company.
orecasting Per.ormance
=ow that we have some insihts into future rowth, we can deve"op a set of performance
scenarios. ,ince no#one can accurate"y predict the future, we shou"d deve"op at "east three
performance scenarios:
+. Conservative ,cenario: Future rowth wi"" be s"ow and dec"ine over time.
2. Ienera" &ndustry ,cenario: Continued moderate rowth simi"ar to the overa"" industry.
4. &mproved Irowth ,cenario: Manaement has the abi"ity to inf"uence "eve" + va"ue drivers
and we can e'pect above averae rowth.
;eep in mind that performance scenarios have a "ot of assumptions and many of these
assumptions are based on thins "i$e future competition, new techno"oies, chanes in the
economy, chanes in consumer behavior, etc. %he end#resu"t is to arrive at a Emost "i$e"yE
va"ue between the different scenarios.
E'amp"e A # .vera"" >a"ue per %hree ,cenarios
Mou have ca"cu"ated three =et Present >a"ue<s 2=P>3 over a +2 year
forecast period. 6ased on your ana"ysis of va"ue drivers, strateies,
competition, and other variab"es, you have assined the fo""owin va"ues to
each scenario:
,cenario Probabi"ity ' =et Present >a"ue F E'pected >a"ue
Conservative 2*7 8 +L*,*** 8 4@,***
=orma" @97 5@*,*** 2AA,***
M C A Irowth +97 9A*,*** LL,9**
.vera"" >a"ue of %aret Company 8 524,9**
%he >a"uation Mode" shou"d inc"ude a comp"ete set of forecasted financia" statements.
Ksua""y a set of forecasted financia" statements wi"" start with the ,a"es Forecast since sa"es
is a driver behind many account ba"ances. A ood sa"es forecast wi"" ref"ect future e'pected
chanes in sa"es prices, vo"umes, and other variab"es.
=.%E: For more information about preparin forecasted financia" statements, refer to ,hort
Course 2 # Financia" P"annin C Forecastin.
/0
%wo important points when preparin your forecast are:
Historica" Perspective: Ma$e sure the pieces of your forecast fit toether and f"ow from
historica" performance. Historica" va"ues are very important for predictin the future. Mou can
ain an historica" perspective by simp"y p"ottin financia" trends 2see E'amp"e +*3.
Forecast Period: Mour forecast period shou"d cover a "on enouh period for the taret
company to reach a stab"e and consistent performance "eve". For e'amp"e, a company has
reached a stab"e point when it can earn a constant rate of return on capita" for an indefinite
period and the company has the abi"ity to reinvest a constant proportion of earnins bac$ into
the business.
?are"y is the forecast period "ess than seven years. /hen in doubt, use a "oner forecast
than a shorter forecast.
%he fina" step in forecastin the financia"s is to estimate the va"ue drivers and verify the va"ue
drivers aainst historica" facts. As we indicated, three core drivers are return on capita", free
cash f"ow, and economic va"ue added. Ma$e sure you test your resu"tsB are $ey drivers
consistent with what has happened in the past, what are the trends for future rowth, what
are the competitive trends, how wi"" this impact performance, etc.0
E'amp"e +* # P"ottin Historica" %rends to he"p with preparin forecasted
financia" statements
+AA* +AA+ +AA2 +AA4 +AA5
.perations:
Irowth in ?evenues +57 +27 ++7 ++7 +*7
Irowth in Marins H7 H7 @7 97 97
/or$in Capita":
Cash 27 27 27 47 47
Accts ?ec +27 +47 +47 +47 +57
Accts Payab"e 57 57 97 97 97
&nvestments:
Assets to ,a"es 4*7 4+7 2L7 2A7 2L7
?eturn on Capita" +57 +27 +47 +47 +27
/hen we have comp"eted the >a"uation Mode", we wi"" have a set of forecasted financia"
statements supportin each of our scenarios:
Forecasted &ncome ,tatement # 4 ,cenarios
Forecasted 6a"ance ,heet # 4 ,cenarios
Forecasted Free Cash F"ows # 4 ,cenarios
Forecasted ?eturn on Capita" # 4 ,cenarios
Forecasted Performance ?atios # 4 ,cenarios
//
E'amp"e ++ # Forecasted &ncome ,tatement for ,cenario 2 # Moderate
28 mi""ion3
2**+ 2**2 2**4 2**5 2**9 2**@ 2**H
?evenues 8 @.9* 8 @.H* 8 @.L9 8@.A9 8H.*9 8H.*A 8H.+2
:ess .peratin 4.2* 4.4* 4.5+ 4.94 4.@9 4.H2 4.HL
:ess 1epreciation .9@ .95 .92 .L9 .L* .HH .H2
E6&% 2.H5 2.L@ 2.A2 2.9H 2.@* 2.@* 2.@2
:ess &nterest .5*9 .4L* .4@9 .59* .55* .5+* .4A*
Earnins 6efore %a' 2.449 2.5L* 2.999 2.+2 2.+@ 2.+A 2.24
:ess %a'es .HL* .L+* .LH* .@9* .@@* .H+ .H4
=et &ncome +.999 +.@H* +.@L9 +.5H* +.9** +.5L +.9*
)erminal Values
&t is !uite possib"e that free cash f"ows wi"" be enerated we"" beyond our forecast period.
%herefore, many va"uations wi"" add a termina" va"ue to the va"uation forecast. %he termina"
va"ue represents the tota" present va"ue that we wi"" receive after the forecast period.
E'amp"e +2 # Addin %ermina" >a"ue to >a"uation Forecast
=et Present >a"ue for forecast period 2E'amp"e A3 8 524,9**
%ermina" >a"ue for beyond forecast period +L4,@**
%ota" =P> of %aret Company 8 @*H,+**
%here are severa" approaches to ca"cu"atin the termina" va"ue:
1ividend Irowth: ,imp"y ta$e the free cash f"ow in the fina" year of the forecast, add a
nomina" rowth rate to this f"ow and discount the free cash f"ow as a perpetuity. %ermina"
va"ue is ca"cu"ated as:
%ermina" >a"ue F FCF 2 t G + 3 ( wacc #
2 t G + 3 refers to the first year beyond the forecast period
wacc: weihted averae cost of capita"
: rowth rate, usua""y a very nomina" rate simi"ar to the overa"" economy
&t shou"d be noted that FCF used for ca"cu"atin termina" va"ues is a norma"iDed free cash
f"ow 2FCF3 representative of the forecast period.
E'amp"e +4 # Ca"cu"ate %ermina" >a"ue Ksin 1ividend Irowth
Mou have prepared a forecast for ten years and the norma"iDed free cash
f"ow is 8 59,***. %he rowth rate e'pected after the forecast period is 47.
%he wacc for the %aret Company is +27.
28 59,*** ' +.*43 ( 2.+2 # .*43 F 8 5@,49* ( .*A F 8 9+9,***
/2
&f we wanted to e'c"ude the rowth rate in E'amp"e +4, we wou"d ca"cu"ate termina" va"ue as
8 5@,49* ( .+2 F 8 4L@,29*. %his ives us a much more conservative estimate.
Ad-usted Irowth: Irowth is inc"uded to the e'tent that we can enerate returns hiher than
our cost of capita". As a company rows, you must reinvest bac$ into the business and thus
free cash f"ows wi"" fa"". %herefore, the Ad-usted Irowth approach is one of the more
appropriate mode"s for ca"cu"atin termina" va"ues.
%ermina" >a"ue F E6&% 2 + # tr3 2 + # ( r 3 ( wacc #
tr: ta' rate : rowth rate r: rate of return on new investments
E'amp"e +5 # Ca"cu"ate %ermina" >a"ue Ksin Ad-usted Irowth
=orma"iDed E6&% is 8 @*,*** and the e'pected norma" ta' rate is 4*7. %he
overa"" "on#term rowth rate is 47 and the weihted averae cost of capita"
is +27. /e e'pect to obtain a rate of return on new investments of +97.
8 @+,L** 2 + # .4* 3 2 + # .*4 ( .+9 3 ( 2.+2 # .*43 F
8 54,2@* 2 .L* 3 ( .*A F 8 4L5,944
&f we use Free Cash F"ows, we wou"d have the fo""owin type of ca"cu"ation:
Earnins 6efore &nterest %a'es 2E6&%3 8 @*,***
?emove ta'es 2+ # tr 3 ' .H*
.peratin &ncome After %a'es 52,***
1epreciation 2non cash item3 +2,***
:ess Capita" E'penditures 2 A,***3
:ess Chanes to /or$in Capita" 2 +,***3
Free Cash F"ow 55,***
Irowth ?ate N 47 ' +.*4
Free Cash F"ow 2 t G + 3 59,42*
Ad-ust Irowth O ?eturn on Capita" ' .L*
Ad-usted FCF 2 t G + 3 4@,29@
1ivided by wacc # or .+2 # .*4 .*A
%ermina" >a"ue 8 5*2,L55
E>A Approach: &f your va"uation is based on economic va"ue added 2E>A3, then you shou"d
e'tend this concept to your termina" va"ue ca"cu"ation:
%ermina" >a"ue F =.PA% 2 t G + 3 ' 2 + # ( rc 3 ( wacc #
=.PA%: =et .peratin Profits After %a'es rc: return on invested capita"
%ermina" va"ues shou"d be ca"cu"ated usin the same basic mode" you used within the
forecast period. Mou shou"d not use P ( E mu"tip"es to ca"cu"ate termina" va"ues since the
price paid for a taret company is not derived from earnins, but from free cash f"ows or E>A.
Fina""y, termina" va"ues are appropriate when two conditions e'ist:
+. %he %aret Company has consistent profitabi"ity and turnover of capita" for eneratin a
constant return on capita".
/#
2. %he %aret Company is ab"e to reinvest a constant "eve" of cash f"ow because of
consistency in rowth.
&f these two criteria do not e'ist, you may need to consider a more conservative approach to
ca"cu"atin termina" va"ue or simp"y e'c"ude the termina" va"ue a"toether.
E'amp"e +9 # ,ummariDe >a"uation Ca"cu"ation 6ased on E'pected >a"ues
under %hree ,cenarios
Present >a"ue of FCF<s for +* year forecast period 8 @2,9**
%ermina" >a"ue based on Perpetuity LH,2**
Present >a"ue of =on .peratin Assets L,@**
%ota" >a"ue of %aret Company +9L,4**
:ess .utstandin 1ebt at Fair Mar$et >a"ue:
,hort#%erm =otes Payab"e 2 @,L9*3
:on#%erm 6onds 229 year Irade 663 2 2@,59*3
:on#%erm 6onds 2+* year Irade AAA3 2 4+,A**3
:on#%erm 6onds 2 9 year Irade 6663 2 22,H**3
Present >a"ue of :ease .b"iations 2 +H,LL*3
%ota" >a"ue Assined to E!uity 92,92*
.utstandin ,hares of ,toc$ H,***
>a"ue per ,hare 28 92,92* ( H,***3 8 H.9*
E'amp"e +@ # Ca"cu"ate >a"ue per ,hare
Mou have comp"eted the fo""owin forecast of free cash f"ows for an eiht
year period, capturin the norma" business cyc"e of Arbor Company:
Mear FCF
2**+ 8 +,99*
2**2 +,9H4
2**4 +,9AL
2**5 +,@2@
2**9 +,@9@
2**@ +,@L*
2**H +,H*4
2**L +,H29
Arbor has non#operatin assets of 8 +9*. %hese assets have an estimated
present va"ue of 8 9**. 6ased on the present va"ue of future payments, the
present va"ue of debt is 8 2,L**. %ermina" va"ue is ca"cu"ated usin the
dividend rowth mode". A nomina" rowth rate of 27 wi"" be used. Arbor<s
tareted cost of capita" is +57. Arbor has 4,*** shares of stoc$ outstandin.
/hat is Arbor<s >a"ue per ,hare0
Mear FCF ' P.>. N +57 Present >a"ue
2**+ 8 +,99* .LHH2 8 +,4@*
2**2 +,9H4 .H@A9 +,2+*
2**4 +,9AL .@H9* +,*HA
2**5 +,@2@ .9A2+ A@4
2**9 +,@9@ .9+A5 L@*
/4
2**@ +,@L* .599@ H@9
2**H +,H*4 .4AA@ @L+
2**L +,H29 .49*@ @*9
%ota" Present >a"ue for Forecast Period 8 H,924
%ermina" >a"ue F 28 +,H29 ' +.*23 ( 2.+5 # .*23 F +5,@@4
>a"ue of =on .peratin Assets 9**
%ota" >a"ue of Arbor 22,@L@
:ess >a"ue of 1ebt 2 2,L**3
>a"ue of E!uity +A,LL@
,hares .utstandin 4,***
>a"ue per ,hare 8 @.@4
Special Pro1lems
6efore we "eave va"uations, we shou"d note some specia" prob"ems that can inf"uence the
va"uation ca"cu"ation.
Private Companies: /hen va"uin a private company, there is no mar$etp"ace for the private
company. %his can ma$e comparisons and other ana"ysis very difficu"t. Additiona""y, comp"ete
historica" information may not be avai"ab"e. Conse!uent"y, it is common practice to add to the
discount rate when va"uin a private company since there is much more uncertainty and ris$.
Forein Companies: &f the taret company is a forein company, you wi"" need to consider
severa" additiona" variab"es, inc"udin trans"ation of forein currencies, differences in
reu"ations and ta'es, "ac$ of ood information, and po"itica" ris$. Mour forecast shou"d be
consistent with the inf"ation rates in the forein country. A"so, "oo$ for hidden assets since
forein assets can have sinificant differences between boo$ va"ues and mar$et va"ues.
Comp"ete Contro": &f the taret company arees to re"in!uish comp"ete and tota" contro" over
to the ac!uirin firm, this can increase the va"ue of the taret. %he va"ue assined to contro" is
e'pressed as:
C> F C G M
C>: Contro""in >a"ue
C: Ma'imum price the buyer is wi""in to pay for contro" of the taret company
M: Minority >a"ue or the present va"ue of cash f"ows to minority shareho"ders.
&f the merer is not e'pected to resu"t in enhanced va"ues 2syneries3, then the ac!uirin firm
cannot -ustify payin a price above the minority va"ue. Minority va"ue is sometimes referred to
as stand#a"one va"ue.
/'
Post
Merger
Integration
/e have now reached the fifth and fina" phase within the merer and ac!uisition process,
interation of the two companies. Kp to this point, the process has focused on puttin a dea"
toether. =ow comes the hard part, ma$in the merer and ac!uisition wor$. &f we did a ood
-ob with due di"ience, we shou"d have the foundation for post merer interation. However,
despite due di"ience, we wi"" need to address a mu"titude of issues, such as:
Fina"iDin a common stratey for the new oraniDation. /e need to be carefu" not to
impose one stratey onto the other company since it may not fit.
Conso"idatin dup"icative services, such as human resources, finance, "ea", etc.
Conso"idatin compensation p"ans, corporate po"icies, and other operatin procedures.
1ecidin on what "eve" of interation shou"d ta$e p"ace.
1ecidin on who wi"" overn the new oraniDation, what authority peop"e wi"" have, etc.
&t is ironic that in many cases, senior manaement is active"y invo"ved in puttin the merer
toether, but once everythin has been fina"iDed, the -ob of interatin the two companies is
dumped on midd"e "eve" manaement. %herefore, one of the first thins that shou"d happen
within post merer interation is for senior manaement to:
1eve"op an overa"" p"an for interatin the two companies, inc"udin a time frame since
synery va"ues need to be recovered !uic$"y. &f synery va"ues are dependent upon the
taret<s customers, mar$ets, assets, etc., then a fast interation process shou"d be
p"anned. &f e'pected syneries come from strateies and inte""ectua" capita" of the taret,
a more cautious approach to interation may be appropriate.
1irectin and uidin the interation process, estab"ishin overnance, and assinin
pro-ect manaers to interation pro-ects.
:eadin chane throuh reat communication, brinin peop"e toether, reso"vin issues
before they manify, estab"ishin e'pectations, etc.
.nce the two companies announce their merer, an entire set of dynamics oes into motion.
Kncertainty and chane sudden"y impact both companies. ,evera" issues need to be
manaed to prevent the escape of synery va"ues.
Chapter
(
/(
Managing t!e Process
%he interation of two companies is manaed within a sin"e, centra"iDed structure in order to
reduce dup"ication and minimiDe confusion. A centra"iDed structure is a"so needed to pu""
everythin toether since the interation process tends to create a "ot of diverent forces. A
,enior Pro-ect %eam wi"" be responsib"e for manain post merer interation 2PM&3. %his
inc"udes thins "i$e coordination of pro-ects, assinin tas$, providin support, etc. As
previous"y indicated, it is important for both senior manaement and midd"e manaement to
share in the interation process:
,enior Manaement ,enior Pro-ect %eam
Cu"tura" C ,ocia" &nteration Functiona" &nteration
,trateic Fit between the Companies ,e"ection of 6est Practices
Communication ,et up %as$ Forces
&dentify Critica" &ssues
Prob"em ,o"vin
%he ,enior Pro-ect %eam wi"" consist of representatives from both companies, coverin
severa" functiona" areas 2human resources, mar$etin, operations, finance, etc.3. %eam
members shou"d have a very stron understandin of the business since they are tryin to
capture synery va"ues throuhout PM&.
,pecia" tas$ forces wi"" be estab"ished by the ,enior Pro-ect %eam to interate various
functions 2finance, information techno"oy, human resources, etc.3. %as$ forces are a"so used
to address specific issues, such as customer retention, non#disruption of operations, retention
of $ey personne", etc. %as$ forces can create sub#teams to sp"it an issue by eoraphic area,
product "ine, etc.
A"" of these teams must have a c"ear understandin of the reasons behind the merer since it
is everybody<s -ob to capture syneries. %here is no way senior manaement can fu""y identify
a"" of the e'pected syneries from a merer and ac!uisition.
&t is not unusua" for some tas$ forces to bein meetin before the merer is announced. &f
interation beins before announcement of the merer, team members wi"" have to act in a
confidentia" manner, e'ercisin care on who they share information with. %he best approach
is to act as thouh a merer wi"" not ta$e p"ace.
E'amp"e +H # %ime"ine "eadin up to Post Merer &nteration 2PM&3
)une 2+, +AAL: .fficers from both companies p"an post merer interation.
)u"y +H, +AAL: .rientation meetin for $ey manaement personne" from
both companies.
)u"y 4*, +AAL: Pro-ect Manaers are assined to %as$ Forces.
Auust +@, +AAL: :aunch %as$ Forces.
Auust 2H, +AAL: Critica" &ssues are identified by %as$ Forces. ,et oa"s
and time frames.
.ctober 2@, +AAL: %as$ Force deve"ops detai" p"an for PM&.
.ctober 4*, +AAL: ?each consensus on fina" p"an.
/7
=ovember @, +AAL: .fficers from both companies approve detai" interation
p"ans.
=ovember ++, +AAL: .peratin 2action steps3 are out"ined for imp"ementin
the PM& P"an.
)anuary +H, +AAA: 6ein Post Merer &nteration
E'amp"e +L # .ut"ine for Post Merer &nteration 2PM&3 by ,enior %as$
Force or ,enior Pro-ect %eam
+. Assess current situation # where do we stand0
2. Co""ect information and identify critica" issues for interation.
4. 1eve"op p"ans to reso"ve critica" issues.
5. .btain consensus and aree on PM& P"an.
9. %rain personne", prepare for interation, wor$ out "oistics, map out the
process, etc.
@. &mp"ement PM& P"an # conduct meetins, setup teams, provide direction,
ma$e $ey decisions, etc.
H. ?evise the PM& P"an # measure and monitor proress, ma$e ad-ustments,
issue proress reports to e'ecutive manaement, etc.
L. 1e"eate # Move the interation process down into "ower "eve"s of the
oraniDation, a""ow staff personne" to contro" certain interation decisions,
etc.
A. Comp"ete # Move aressive"y into fu"" interation, coordinate and
communicate proress unti" interation is comp"ete.
$ecision Ma2ing
Post merer interation 2PM&3 wi"" re!uire very !uic$ decision#ma$in. %his is due in part to
the fact that fast interation<s wor$ better than s"ow interation<s. %he new oraniDation has to
be estab"ished !uic$"y so peop"e can et bac$ to servicin customers, desinin products,
etc. %he more time peop"e spend thin$in about the merer, the "ess "i$e"y they wi"" perform at
hih "eve"s.
Many decisions within PM& wi"" be difficu"t, such as estab"ishin the new oraniDationa"
structure, re#assinin personne", se""in#off assets, etc. However, it is necessary to et these
decisions behind you as !uic$"y as possib"e since the synery meter is runnin. &n addition,
fai"ure to act wi"" "eave the impression of indecisiveness and inabi"ity to manae PM&.
&n order to ma$e decisions, it is necessary to define ro"esB peop"e need to $now who is in
chare. Peop"e who are responsib"e for interation shou"d be hih"y s$i""ed in coordinatin
pro-ects, "eadin peop"e, and thin$in on their feet whi"e stayin focused on the strateies
behind the merer and ac!uisition.
/+
People Issues
Productivity and performance wi"" usua""y drop once a merer is announced. %he reason is
simp"eB peop"e are concerned about what wi"" happen. &n the boo$ %he Comp"ete Iuide to
Merers and Ac!uisitions, the authors note that Eat "east 4@*,*** hours of "ost productivity
can be "ost durin an ac!uisition of -ust a thousand person operation.E
Puic$ and open communication is essentia" for manain peop"e issues. Constant
communication is re!uired for addressin the rumors and !uestions that arise within PM&.
Peop"e must $now what is oin on if they are e'pected to remain focused on their -obs.
Communication shou"d be deep and broad, reachin out to as many peop"e as possib"e.
Face to face communication wor$s best since there is an opportunity for feedbac$. Even
cursory communication is better than no communication at a"".
EIet a"" the facts out. Iive peop"e the rationa"e for chane, "ayin it out in
the c"earest, most dramatic terms. /hen everybody ets the same facts,
they<"" enera""y come to the same conc"usion. .n"y after everyone arees
on the rea"ity and resistance is "owered can you et buy#in to the needed
chanes.E # )ac$ /e"ch, CE., Ienera" E"ectric
&t is a"so a ood idea to train peop"e in chane manaement. Most peop"e wi"" "ac$ the
$now"ede and s$i""s re!uired for PM&. &mmediate"y after the merer is announced, $ey
personne" shou"d receive trainin in how to manae chane and ma$e !uic$ decisions.
Peop"e must fee" competent about their abi"ities to pu"" off the interation.
Managing %esistance
%he fai"ure to manae resistance is a ma-or reason for fai"ed merers. ?esistance is natura"
and not necessari"y indicative of somethin wron. However, it cannot be inored. Four
important too"s for manain resistance are:
Communicate: As we -ust indicated, you have to ma$e sure peop"e $now what is oin on if
you e'pect to minimiDe resistance. ?umors shou"d not be the main form of communication.
%he fo""owin !uote from a midd"e "eve" manaer at a meetin with e'ecutive manaement
says it a"":
EHow can & te"" my peop"e what needs to be done to interate the two companies,
when & have heard nothin about what is oin on.E
%rainin: As we -ust noted, peop"e must possess the necessary s$i""s to manae PM&.
&nvestin in peop"e throuh trainin can he"p achieve Ebuy#inE and thus, "ower resistance.
&nvo"vement: ?esistance can be reduced by inc"udin peop"e in the decision ma$in process.
Active enaement can a"so he"p identify prob"em areas.
A"inment: .ne way to buffer aainst resistance is to a"in yourse"f with those peop"e who
have accepted the merer. K"timate"y, it wi"" be the non#resistors who brin about the
interation. 1o not waste e'cessive resources on detractorsB they wi"" never come around.
/-
Closing t!e Cultural 3ap
.ne of the biest cha""enes within PM& is to c"ose the cu"tura" divide between the two
companies. Cu"tura" differences shou"d have been identified within Phase && 1ue 1i"ience.
.ne way of c"osin the cu"tura" ap is to invent a third, new corporate cu"ture as opposed to
forcin one cu"ture onto another company. A re#desin approach can inc"ude:
?educin the number of ru"es and po"icies that contro" peop"e. &n today<s empowered
wor"d, it has become important to un"eash the human capacities within the oraniDation.
Create a set of corporate po"icies centered around the strateic oa"s and ob-ectives of
the new oraniDation.
&mp"ement new innovative approaches to human resource manaement, such as the
4@*#deree eva"uation.
E"iminate various forms of communication that continue with the Eo"d wayE of doin
thins.
?e#enforce the new ways with incentive prorams, rewards, reconition, specia" events,
etc.
Speci.ic Areas o. Integration
As we move forward with the interation process, a new oraniDationa" structure wi"" unfo"d.
%here wi"" be new reportin structures based on the needs of the new company. ,tructures
are bui"t around wor$f"ows. For best resu"ts, co""aboration shou"d ta$e p"ace between the two
companiesB mi'in peop"e, combinin offices, sharin faci"ities, etc. %his co""aboration he"ps
pu"" the new oraniDation toether. As noted ear"ier, a centra"iDed oraniDation wi"" e'perience
"ess difficu"ty with PM& than a decentra"iDed oraniDation. Co""aboration is a"so enhanced
when there are:
,hared Ioa"s # %he more common the oa"s and ob-ectives of the two companies, the
easier it is to interate the two companies.
,hared Cu"tures # %he more common the cu"tures of the two companies, the easier the
interation.
,hared ,ervices # %he c"oser both company<s can come to deve"opin a set of shared
services 2human resource manaement, finance, etc.3, the more "i$e"y syneries can be
rea"iDed throuh e"imination of dup"icative services.
Many functiona" areas wi"" have to be interated. Each wi"" have its own interation p"an, "ed
by a %as$ Force. %wo areas of concern are compensation and techno"oies.

Compensation P"ans: &t is important to ma$e compensation p"ans between the two
companies as uniform as possib"e. Fai"ure to c"ose the compensation ap can "ead to division
within the wor$force. Compensation p"ans shou"d be desined based on a ba"ance between
past practices and future needs of the company. ,ince "ost productivity is a ma-or issue,
compensation based on performance shou"d be a ma-or focus.
%echno"oies: /hen decidin which information system to $eep between the two companies,
ma$e sure you as$ yourse"f the fo""owin !uestions:
20
1o we rea""y need this information0
&s the information time"y0
&s the information accurate0
&s the information accessib"e0
.ne of the misconceptions that may emere is to retain the most current, "eadin#ede
techno"oy. %his may be a mista$e since o"der "eacy systems may be we"" tested and
re"iab"e for future needs of the oraniDation. &f both systems between the two companies are
outdated, a who"e new system may be re!uired.
%etaining 4e* Personnel
Merers often resu"t in the "oss of $ey 2essentia"3 personne". ,ince syneries are hih"y
dependent upon !ua"ity personne", it wi"" be important to ta$e steps for retainin the hih
performers of the %aret Company.
%he first step is to identify $ey personne". As$ yourse"f, if these peop"e were to "eave, what
impact wou"d it have on the company0 For e'amp"e, suppose a Mar$etin Manaer decided
to resin, resu"tin in the "oss of critica" customers. .ther peop"e may be critica" to strateic
thin$in and innovation.
.nce you have a "ist of $ey personne", the ne't step is to determine what motivates essentia"
personne". ,ome peop"e are motivated by their wor$ whi"e others are interested in c"imbin
the corporate "adder. ?etention prorams are desined around these motivatin factors.
%he third step is to imp"ement your retention prorams. Persona""y communicate with $ey
personne"B "et them $now what their position wi"" be in the new company. &f compensation is a
motivatin factor, offer $ey personne" a EstayE bonus. &f peop"e are motivated by career
advancement, invite them to important manaement meetins and have them participate in
decision ma$in. 1on<t foret to reinforce retention by reconiDin the contributions made by
$ey personne". &t is a"so a ood idea to recruit $ey personne" -ust as if you wou"d recruit any
other $ey manaement position. %his so"idifies the retention process.
Fina""y, you wi"" need to eva"uate and modify retention prorams. For e'amp"e, if $ey peop"e
continue to resin, then conduct an e'it interview and find out why they are "eavin. Kse this
information to chane your retention proramsB otherwise, more peop"e wi"" be defectin.
%etaining Customers
Merers wi"" obvious"y create some disruptions. .ne area where disruptions must be
minimiDed is customer service. .nce a merer is announced, communicate to your
customers, informin them that products and services wi"" not deteriorate due to the merer.
Additiona""y, emp"oyees direct"y invo"ved with customer service cannot be distracted by the
merer.
&f customers are e'pected to defect, consider offerin specia" dea"s and prorams to reinforce
customer retention. As a minimum, consider settin up a customer hot"ine to answer
2/
!uestions. Fina""y, do not foret to communicate with vendors, supp"iers, and others invo"ved
in the va"ue chain. %hey too are your customers.
Measuring PMI
%he "ast area we want to touch on is measurement of post merer interation 2PM&3. ?esu"ts
of the interation process need to be captured and measured so that you can identify
prob"em areas and ma$e corrections. For e'amp"e, are we ab"e to retain $ey personne"0
How effective is our communication0 /e need answers to these types of !uestions if we
e'pect success in PM&.
.ne way of ensurin feedbac$ is to retain the current measurement systems that are in
p"aceB especia""y those invo"ved with critica" areas "i$e customer service and financia"
reportin. 1ay to day operations wi"" need to be monitored for sudden chanes in customer
comp"aints, return merchandise, cance""ed orders, production stoppaes, etc. =ew
measurements for PM& wi"" have to be simp"e and easy to dep"oy since there is "itt"e time for
forma" desin. For e'amp"e, in one case the PM& re"ied on a web site "o to capture critica"
data, identify synery pro-ects, and report PM& proress. .n#"ine survey forms were used to
so"icit input and identify prob"em areas. A c"ean and simp"e approach wor$s best.
A measurement system starts with a "ist of critica" success factors 2C,F3 re"ated to PM&.
%hese C,F<s wi"" ref"ect the strateic outcomes associated with the merer. For e'amp"e,
combinin two over"appin business units miht represent a C,F for a merer. From these
C,F<s, we can deve"op $ey performance indicators. Co""ective"y, a comp"ete system $nown
as the 6a"anced ,corecard can be used to monitor PM&. Process "eaders are assined to
each perspective within the scorecard, co""ectin the necessary data for measurement.
E'amp"e +A # 6a"anced ,corecard for Post Merer &nteration 2PM&3
Perspective ;ey Performance &ndicator
Customers # ?etention of E'istin Customers
E # Efficiency in 1e"iverin ,ervices
Financia" # ,ynery Components Captured to 1ate
E # %ime"y Financia" ?eportin
E # %ime"y Cash F"ow Manaement
.perationa" # Comp"etion of ,ystems Ana"ysis
E # ?eassinments to a"" .peratin Knits
E # ?esources A""ocated for /or$"oads
Human ?esource # Percentae of Personne" 1efections
E # Chane Manaement %rainin
E # Communication Feedbac$s
.raniDationa" # Cu"tura" Iaps between company<s
E # =umber of Critica" Processes 1efined
E # :ower "eve" invo"vement in interation
22
Anti5
)a2eo,er $e.enses
%hrouhout this entire short course 2parts + C 23, we have focused our attention on ma$in
the merer and ac!uisition process wor$. &n this fina" chapter, we wi"" do -ust the oppositeB we
wi"" "oo$ at ways of discourain the merer and ac!uisition process. &f a company is
concerned about bein ac!uired by another company, severa" anti#ta$eover defenses can be
imp"emented. As a minimum, most companies concerned about ta$eovers wi"" c"ose"y
monitor the tradin of their stoc$ for "are vo"ume chanes.
Poison Pills
.ne of the most popu"ar anti#ta$eover defenses is the poison pi"". Poison pi""s represent rihts
or options issued to shareho"ders and bondho"ders. %hese rihts trade in con-unction with
other securities and they usua""y have an e'piration date. /hen a merer occurs, the rihts
are detached from the security and e'ercised, ivin the ho"der an opportunity to buy more
securities at a deep discount. For e'amp"e, stoc$ rihts are issued to shareho"ders, ivin
them an opportunity to buy stoc$ in the ac!uirin company at an e'treme"y "ow price. %he
rihts cannot be e'ercised un"ess a tender offer of 2*7 or more is made by another
company. %his type of issue is desined to reduce the va"ue of the %aret Company. F"ip#over
rihts provide for purchase of the Ac!uirin Company whi"e f"ip#in rihts ive the shareho"der
the riht to ac!uire more stoc$ in the %aret Company. Put options are used with
bondho"ders, a""owin them to se""#off bonds in the event that an unfriend"y ta$eover occurs.
6y se""in off the bonds, "are principa" payments come due and this "owers the va"ue of the
%aret Company.
3olden Parac!utes
Another popu"ar anti#ta$eover defense is the Io"den Parachute. Io"den parachutes are "are
compensation payments to e'ecutive manaement, payab"e if they depart une'pected"y.
:ump sum payments are made upon termination of emp"oyment. %he amount of
compensation is usua""y based on annua" compensation and years of service. Io"den
parachutes are narrow"y app"ied to on"y the most e"ite e'ecutives and thus, they are
sometimes viewed neative"y by shareho"ders and others. &n re"ation to other types of
ta$eover defenses, o"den parachutes are not very effective.
Chapter
7
2#
C!anges to t!e Corporate C!arter
&f manaement can obtain shareho"der approva", severa" chanes can be made to the
Corporate Charter for discourain merers. %hese chanes inc"ude:
,taered %erms for 6oard Members: .n"y a few board members are e"ected each year.
/hen an ac!uirin firm ains contro" of the %aret Company, important decisions are more
difficu"t since the ac!uirer "ac$s fu"" board membership. A staered board usua""y provides
that one#third are e"ected each year for a 4 year term. ,ince ac!uirin firms often ain contro"
direct"y from shareho"ders, staered boards are not a ma-or anti#ta$eover defense.
,uper#ma-ority ?e!uirement: %ypica""y, simp"e ma-orities of shareho"ders are re!uired for
various actions. However, the corporate charter can be amended, re!uirin that a super#
ma-ority 2such as L*73 is re!uired for approva" of a merer. Ksua""y an Eescape c"auseE is
added to the charter, not re!uirin a super#ma-ority for merers that have been approved by
the 6oard of 1irectors. &n cases where a partia" tender offer has been made, the super#
ma-ority re!uirement can discourae the merer.
Fair Pricin Provision: &n the event that a partia" tender offer is made, the charter can re!uire
that minority shareho"ders receive a fair price for their stoc$. ,ince many states have
adopted fair pricin "aws, inc"usion of a fair pricin provision in the corporate charter may be a
moot point. However, in the case of a two#tiered offer where there is no fair pricin "aw, the
ac!uirin firm wi"" be forced to pay a Eb"endedE price for the stoc$.
1ua" Capita"iDation: &nstead of havin one c"ass of e!uity stoc$, the company has a dua"
e!uity structure. .ne c"ass of stoc$, he"d by manaement, wi"" have much stroner votin
rihts than the other pub"ic"y traded stoc$. ,ince manaement ho"ds superior votin power,
manaement has increased contro" over the company. A word of caution: %he ,EC no "oner
a""ows dua" capita"iDation<sB a"thouh e'istin p"ans can remain in effect.
%ecapitali6ations
.ne way for a company to avoid a merer is to ma$e a ma-or chane in its capita" structure.
For e'amp"e, the company can issue "are vo"umes of debt and initiate a se"f#offer or buy
bac$ of its own stoc$. &f the company see$s to buy#bac$ a"" of its stoc$, it can o private
throuh a "everaed buy out 2:6.3. However, "everaed recapita"iDations re!uire stab"e
earnins and cash f"ows for servicin the hih debt "oads. And the company shou"d not have
p"ans for ma-or capita" investments in the near future. %herefore, "everaed recaps shou"d
stand on their own merits and offer additiona" va"ues to shareho"ders. Maintainin hih debt
"eve"s can ma$e it more difficu"t for the ac!uirin company since a "ow debt "eve" a""ows the
ac!uirin company to borrow easi"y aainst the assets of the %aret Company.
&nstead of issuin more debt, the %aret Company can issue more stoc$. &n many cases, the
%aret Company wi"" have a friend"y investor $nown as a Ewhite s!uireE which see$s a !ua"ity
investment and does not see$ contro" of the %aret Company. .nce the additiona" shares
have been issued to the white s!uire, it now ta$es more shares to obtain contro" over the
%aret Company.
24
Fina""y, the %aret Company can do thins to boost va"uations, such as stoc$ buy#bac$s and
spinnin off parts of the company. &n some cases, the taret company may want to consider
"i!uidation, se""in#off assets and payin out a "i!uidatin dividend to shareho"ders. &t is
important to emphasiDe that a"" restructurins shou"d be directed at increasin shareho"der
va"ue and not at tryin to stop a merer.
7t!er Anti )a2eo,er $e.enses
Fina""y, if an unfriend"y ta$eover does occur, the company does have some defenses to
discourae the proposed merer:
+. ,tand ,ti"" Areement: %he ac!uirin company and the taret company can reach
areement whereby the ac!uirin company ceases to ac!uire stoc$ in the taret for a
specified period of time. %his stand sti"" period ives the %aret Company time to e'p"ore
its options. However, most stand sti"" areements wi"" re!uire compensation to the
ac!uirin firm since the ac!uirer is runnin the ris$ of "osin synery va"ues.
2. Ireen Mai": &f the ac!uirer is an investor or roup of investors, it miht be possib"e to buy
bac$ their stoc$ at a specia" offerin price. %he two parties ho"d private neotiations and
sett"e for a price. However, this type of tareted repurchase of stoc$ runs contrary to fair
and e!ua" treatment for a"" shareho"ders. %herefore, reen mai" is not a wide"y accepted
anti#ta$eover defense.
4. /hite ;niht: &f the taret company wants to avoid a hosti"e merer, one option is to see$
out another company for a more suitab"e merer. Ksua""y, the %aret Company wi"" en"ist
the services of an investment ban$er to "ocate a Ewhite $niht.E %he /hite ;niht
Company comes in and rescues the %aret Company from the hosti"e ta$eover attempt.
&n order to stop the hosti"e merer, the /hite ;niht wi"" pay a price more favorab"e than
the price offered by the hosti"e bidder.
5. :itiation: .ne of the more common approaches to stoppin a merer is to "ea""y
cha""ene the merer. %he %aret Company wi"" see$ an in-unction to stop the ta$eover
from proceedin. %his ives the taret company time to mount a defense. For e'amp"e,
the %aret Company wi"" routine"y cha""ene the ac!uirin company as fai"in to ive
proper notice of the merer and fai"in to disc"ose a"" re"evant information to shareho"ders.
9. Pac Man 1efense: As a "ast resort, the taret company can ma$e a tender offer to
ac!uire the stoc$ of the hosti"e bidder. %his is a very e'treme type of anti#ta$eover
defense and usua""y sina"s desperation.
.ne very important issue about anti#ta$eover defenses is va"uations. Many anti#ta$eover
defenses 2such as poison pi""s, o"den parachutes, etc.3 have a tendency to protect
manaement as opposed to the shareho"der. Conse!uent"y, companies with anti#ta$eover
defenses usua""y have "ess upside potentia" with va"uations as opposed to companies that
"ac$ anti#ta$eover defenses. Additiona""y, most studies show that anti#ta$eover defenses are
not successfu" in preventin merers. %hey simp"y add to the premiums that ac!uirin
companies must pay for taret companies.
2'
Pro8* ig!ts
.ne "ast point to ma$e about chanes in ownership concerns the fact that shareho"ders can
sometimes initiate a ta$eover attempt. ,ince shareho"ders have votin rihts, they can
attempt to ma$e chanes within a company. Pro'y fihts usua""y attempt to remove
manaement by fi""in new positions within the 6oard of 1irectors. %he insurent
shareho"der2s3 wi"" cast votes to rep"ace the current board.
Pro'y fihts bein when shareho"ders re!uest a chane in the board. %he ne't step is to
so"icit a"" shareho"ders and a""ow them to vote by Epro'y.E ,hareho"ders wi"" send in a card to
a desinated co""ector 2usua""y a bro$er3 where votes are ta""ied. ,ome important factors that
wi"" inf"uence the success of a pro'y fiht are:
+. %he deree of support for manaement from shareho"ders not direct"y invo"ved in the
pro'y fiht. &f other shareho"ders are satisfied with manaement, then a pro'y fiht wi"" be
difficu"t.
2. %he historica" performance of the company. &f the company is startin to fai", then
shareho"ders wi"" be much more receptive to a chane in manaement.
4. A specific p"an to turn the company around. &f the shareho"ders who are "eadin the pro'y
fiht have a p"an for improvin performance and increasin shareho"der va"ue, then other
shareho"ders wi"" probab"y support the pro'y fiht.
Pro'y fihts are "ess cost"y than tender offers in chanin contro" within a company. However,
most pro'y fihts fai" to remove manaement. %he upside of a pro'y fiht is that it usua""y
brins about a boost in shareho"der va"ue since manaement is forced to act on poor
performance. &t is worth notin that pro'y fihts are sometimes "ed by former manaers with
the %aret Company who reconiDe what needs to be done to turn the company around. &n
any event, studies c"ear"y show that chanes in manaement are much more "i$e"y to occur
e'terna""y 2tender offers3 as opposed to interna""y 2pro'y fihts3.

Course Summar*
A merer is "i$e a marriaeB the two partners must be compatib"e. Each side shou"d add
va"ue so that toether the two are much stroner. Knfortunate"y, many merers fai" to wor$.
.verpayin for the ac!uisition is a common mista$e because of an incomp"ete va"uation
mode". %herefore, it is essentia" to deve"op a comp"ete va"uation mode", inc"udin ana"ysis
under different scenarios with reconition of va"ue drivers. A ood startin point for
determinin va"ue is to e'tend the 1iscounted Cash F"ow Mode" since it corresponds we"" to
mar$et va"ues. Core va"ue drivers 2such as free cash f"ows3 shou"d be emphasiDed over
traditiona" type earnins 2such as E6&%1A3.
,ome $ey points to remember in the va"uation process inc"ude:
+. Most va"uations wi"" focus on va"uin the e!uity of the %aret Company.
2(
2. %he discount rate used shou"d match#up with the associated ris$ of cash f"ows.
4. %he forecast shou"d focus on "on#term cash f"ows over a period of time that captures a
norma" operatin cyc"e for the company.
5. %he forecast shou"d be rea"istic by fittin with historica" facts.
9. A comprehensive mode" is re!uired based on an understandin of what drives va"ue for
the company.
@. %he fina" forecast shou"d be tested aainst independent sources.
&f pre merer phases are comp"ete, we can move forward to interate the two companies.
%his wi"" re!uire the conversion of information systems, combinin of wor$forces, and other
pro-ects. Many fai"ures can be traced to peop"e prob"ems, such as cu"tura" differences
between the companies, which can "ead to resistance. Additiona""y, if you fai" to retain $ey
personne", the interation process wi"" be much more difficu"t. %he best defense aainst
personne" defections is to have a reat p"ace to wor$. &f the company has a bad reputation as
an emp"oyer, then defections wi"" sure"y occur.
,ome of the ris$ factors associated with post merer interation are:
+. /hat "eve" of interation do we imp"ement0
2. /hat can we do to retain $ey personne"0
4. How serious are the cu"tura" differences between the companies0
5. /hat $inds of conf"icts and competition can we e'pect durin interation0
9. %o what e'tent do the peop"e of both company<s understand the merer0
@. /ho wi"" overn and contro" the new company0
,uccess with post merer interation is improved when:
+. %he two companies have a history of effective p"annin and strateiDin.
2. %he two companies have a history of successfu" chane manaement.
4. %he merer wi"" improve the strateies of both companies.
5. ,ufficient resources are a""ocated for interatin the two companies.
9. &nteration ta$es p"ace by desin and not by chance.
@. 6oth company<s have prepared for interation in advance throuh due di"ience.
H. Human and cu"tura" issues are direct"y addressed as part of interation.
L. %he interation process is viewed as evo"utionary with severa" concurrent pro-ects oin
on, tryin to interate the two companies as !uic$"y as possib"e.
Fina""y, not a"" companies wi"" open"y embrace merersB substitutin interna" investment for
e'terna" investment. ,ome companies are very successfu" with their interna" investment
prorams and a sudden shift to e'terna" investments 2merers3 may not fit with the company.
A number of measures can be emp"oyed for preventin a merer, inc"udin:
Poison Pi""s # &ssuin rihts to shareho"ders, e'ercised when a ta$eover attempt occurs.
Io"den Parachutes # ,pecia" compensation paid to e'ecutives shou"d they depart within
one year of a merer.
Chanes to the Corporate Charter # ,taerin the terms of board members and
re!uirin a super#ma-ority approva" for a merer.
?ecapita"iDations # Ma$in ma-or chanes to the capita" structure, such as "are issues of
debt to buy bac$ the stoc$.
27
However, despite a"" of these anti#ta$eover defenses, most ac!uirin companies are
successfu" in ta$in contro" of the %aret Company. Additiona""y, the stoc$ prices for
companies with anti#ta$eover defenses are discounted for the obstac"es encountered in
tryin to remove manaement.
inal 98am
,e"ect the best answer for each !uestion. E'ams are raded and administered by insta""in
the e'e fi"e version of this course. %he e'e fi"e can be down"oaded over the internet at
www.e'infm.com(trainin.
+. Assumin we are va"uin a oin concern, which of the fo""owin types of income
streams wou"d be most appropriate for va"uin the company0
a. Earnins 6efore &nterest and %a'es
b. Free Cash F"ows
c. .peratin &ncome After %a'es
d. Price to Earnins ?atio
2. %he fo""owin estimates have been made for the year 2**@:
.peratin &ncome 2E6&%3 8 @,***
1epreciation 9**
Cash %a'es to be paid A9*
&ncome from non operatin assets @*
=o capita" investments or chanes to wor$in capita" are e'pected. 6ased on this
information, the pro-ected free cash f"ows for 2**@ are:

a. 8 9,@+*.
b. 8 5,99*.
c. 8 5,5A*
d. 8 @,99*
4. Marsha"" Company is considerin ac!uirin :inco"n Associates for 8 @**,***. :inco"n has
tota" outstandin "iabi"ities va"ued at 8 2**,***. %he tota" purchase price for Marsha"" to
ac!uire :inco"n is:
2+
a. 8 2**,***
b. 8 5**,***
c. 8 @**,***
d. 8 L**,***
5. %he >a"uation Process wi"" often ana"yDe severa" va"ue drivers in order to understand
where va"ue comes from. /hich of the fo""owin va"ue drivers wou"d be least important to
the va"uation0
a. ?eturn on &nvested Capita"
b. Earnins per ,hare
c. Cash F"ow ?eturn on &nvestment
d. Economic >a"ue Added
9. Mou have been as$ed to ca"cu"ate a termina" va"ue for a va"uation forecast. %he
norma"iDed free cash f"ow within the forecast is 8 ++,5**. A nomina" rowth rate of 47 wi""
be app"ied a"on with a weihted averae cost of capita" of +97. Ksin the dividend
rowth mode", the termina" va"ue that shou"d be added to the forecast is:
a. 8 HL,2L*
b. 8 L@,2**
c. 8 A9,***
d. 8 AH,L9*
@. &nformation from a va"uation mode" for Iemini Corporation is summariDed be"ow:
%ota" present va"ue of forecasted free cash f"ows 8 +9*,***
%ermina" va"ue added 59*,***
%ota" present va"ue of non#operatin assets 2*,***
%ota" present va"ue of outstandin debts +2*,***
&f Iemini has 2*,*** shares of outstandin stoc$, the va"ue per share of Iemini is:

a. 8 +9.**
b. 8 29.**
c. 8 4*.**
2-
d. 8 49.**
H. .nce a merer has been fina"iDed, one of the primary responsibi"ities of senior e'ecutive
manaement as it re"ates to post merer interation is to:
a. Faci"itate functiona" interation
b. 1eve"op personne" retention prorams
c. :ead chane throuh communication
d. Manae a"" of the interation pro-ects
L. .ne of the cha""enes within post merer interation is to retain $ey 2essentia"3 personne".
/hich of the fo""owin miht he"p retain $ey personne"0
a. Assin personne" to new "ocations
b. &nvite personne" to manaement meetins
c. .ffer personne" severance pac$aes
d. ?ecruit personne" different"y than norma"
A. /hich of the fo""owin can be used as a poison pi"" for preventin a merer and
ac!uisition0
a. &ssuin specia" rihts to shareho"ders
b. .fferin o"den parachutes to e'ecutives
c. 6uyin bac$ a"" of the outstandin stoc$
d. Adoptin a super#ma-ority for merers
+*. /hich of the fo""owin represents a chane to the corporate charter, desined to
discourae a chane in manaement0
a. .fferin reenmai" to se"ected shareho"ders
b. Enterin into a standsti"" areement
c. Ioin private throuh a "everaed buyout
d. ,taerin the terms of board members
#0