FREE online courses on Mergers & Acquisitions - Chapter 5 - The Valuation Process 

 

We have set the stage for valuing the Target Company. The overall process is centered around free cash flows and the Discounted Cash Flow (DCF) Model. We will now focus on the finer points in calculating the valuation. In the book Valuation: Measuring and Managing the Value of Companies, the authors Tom Copland, Tim Koller, and Jack Murrin outline five steps for valuing a company:

 

1.        Historical Analysis: A detail analysis of past performance, including a determination of what drives performance. Several financial calculations need to be made, such as free cash flows, return on capital, etc. Ratio analysis and benchmarking are also used to identify trends that will carry forward into the future.

2.        Performance Forecast: It will be necessary to estimate the future financial performance of the target company. This requires a clear understanding of what drives performance and what synergies are expected from the merger.

3.        Estimate Cost of Capital: We need to determine a weighed average cost of capital for discounting the free cash flows.

4.        Estimate Terminal Value: We will add a terminal value to our forecast period to account for the time beyond the forecast period.

5.        Test & Interpret Results: Finally, once the valuation is calculated, the results should be tested against independent sources, revised, finalized, and presented to senior management.