Chapter 8: Relative, Asset-Oriented, and Real Option

Valuation Basics

Answers to End of Chapter Discussion Questions

8.1 Does the application of the comparable companies’ valuation method require the addition of an
acquisition premium? Why? / Why not?

Answer: Yes. The use of multiples of comparable companies to value the earnings of a target firm
would not generally reflect an acquisition premium unless such companies were themselves facing the
prospect of acquisition.

8.2 Which is generally considered more accurate: the comparable companies’ or recent comparable
transactions method? Explain your answer.

Answer: The recent transactions method is generally considered more accurate, as long as the target
firm is truly similar to the firm involved in the recent transaction. Unlike the comparable companies’
method, the recent transactions’ method reflects a price actually paid by a willing buyer and selling at
a specific moment in time. The comparable companies’ approach results in a valuation based on what
investors are willing to pay for a fractional interest in a similar firm and do not reflect a takeover
premium. Comparable companies are not necessarily those in the same industry but can be those
exhibiting similar growth, profitability, and risk characteristics. The degree of comparability can be
determined by estimating the correlation coefficient between the two firms’ financial returns, revenue,
or some other measure of financial performance.

8.3 What are the key assumptions implicit in the comparable companies’ valuation method? The recent
transactions method? Be specific.

Answer: The comparable companies’ method assumes that other firms can be found that are
substantially similar to the target in terms of size, customer mix, growth rate, financial returns,
indebtedness, etc. Moreover, the method assumes that the valuation is unbiased (i.e., not overly
optimistic or pessimistic) at that moment in time. The recent transactions’ method makes similar
assumptions. However, unlike the comparable companies’ approach, the recent transactions method
assumes that the premium built into the purchase price is reflective of what the buyer is willing to pay
for the target over its current value in order to gain a controlling interest.

8.4 Explain the primary differences between the income (discounted cash flow), relative (market-based),
and asset-oriented valuation methods?

Answer: The income method focuses on some measure of cash flow or income. A commonly used technique
to value a company’s cash flow or income stream is the discounted cash flow (DCF) method. The DCF approach
involves forecasting year-by-year results and then converting these annual projections into their
current value or present value by dividing each annual figure by an appropriate discount rate.

The market-based method assumes that markets are efficient in that the current values of businesses
determined in the marketplace embody all the information currently available about the business.
Current values represent what a willing buyer and seller, having access to the same information,
would pay for the business. Using this approach, value is determined by multiplying market-
determined value measures (e.g., price-to-earnings, price-to-book, or price-to-sales ratios of other
firms in the same industry, comparable industries, or comparable recent sales of similar firms) by the
earnings, book value, or sales of the firm to be valued. The resulting calculation provides an estimate
of the present or current value of the firm.

Asset-oriented approaches, such as tangible book, liquidation, and breakup values, are useful in highly
specialized situations. The calculation of tangible book value per share, book value less goodwill, may
 be very useful in valuing financial services and distribution companies, because highly liquid assets
often comprise a large percentage of the total assets of such firms. The liquidation value of a firm is
the current market value of the firm’s assets as if it is going out of business less the cash value of its
liabilities and costs incurred to liquidate the firm. Asset-oriented approaches ignore potential synergies
that might exist among the various operations comprising the business

8.5 Under what circumstances might it be more appropriate to use relative valuation methods rather than
the DCF approach? Be specific.

Answer: Market multiples are often used when there is insufficient current and historical data about
the target firm to measure the components of cash flow and to determine its key drivers. This is
particularly true for privately owned firms. Moreover, market multiples are sometimes believed to be
more accurate than DCF, because they reflect market-based factors, while DCF analysis is often
subject to the biases of the analyst measuring and projecting the cash flows.

8.6 PEG ratios allow for the adjustment of relative valuation methods for the expected growth of the firm.
How might this be helpful in selecting potential acquisition targets? Be specific?

Answer: PEG ratios can be helpful in the process of searching for potential acquisition targets. When
faced with multiple potential targets, it is sometimes difficult to identify the most attractive candidate
simply by looking at their growth rates, market multiples, market values, earnings, etc., because these
data may differ significantly for the various firms under consideration. This is especially difficult when
comparing firms with different multiples and expected growth rates. For example, a firm with a low
market multiple relative to its expected growth rate may suggest that investors do not anticipate that
the higher earnings growth rate will necessarily translate into higher financial returns, perhaps due to
the growing reinvestment requirements of the business. Consequently, it may be appropriate to
compare the firms on an “apples to apples” basis by calculating the PEG ratio for each in an effort to
see which are over and which are undervalued.

8.7 How is the liquidation value of the firm calculated? Why is the assumption of orderly liquidation
important?

Answer: Liquidation or breakup value is the projected price of the firm’s assets sold separately less its
liabilities and the
administrative and legal costs associated with the sale of the asset. Liquidation may be involuntary as a result of bankruptcy or
voluntary if a firm is viewed by its owners as worth more in liquidation than as a going concern. The assumption of
orderly
liquidation is important because it assumes that those responsible for liquidating the firm’s assets
have sufficient time to find
enough buyers willing to pay the fair market value of the assets.

8.8 What are real options and how are they applied in valuing acquisitions?

Answer: Real options represent the opportunities for management to change their decisions once they have been made in the
face of new information. They give management the ability to expand, delay, or abandon their investment. They add potential
value to the acquisition by either potentially increasing financial returns or reducing risk.

8.9 Give examples of pre- and post-closing real options.

Answer: Before closing, a buyer may choose to make closing contingent on the realization of a specific event (e.g., obtaining
regulatory acceptance for a new product) or a potential suitor may only acquire a toehold investment in the target firm until more
information is available as to the true value of the target. Following closing, the buyer can postpone or delay new investment in
the target firm until new data are available or divest the acquired business if certain performance goals are not met.

8.10 Conventional DCF analysis does not incorporate the effects of real options into the valuation of an asset. How might an analyst

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 incorporate the potential impact of real options into conventional DCF valuation methods?

Answer: The value contributed by real options can be incorporated into conventional DCF analysis in several ways. One way to
do this is to use a decision tree approach in which management values the cash flows generated by each reasonable option,
estimates the probabilities associated with each option, and estimates an expected value of the range of available options.
Alternatively, if the options exhibit the characteristics of a financial option, they can be valued as a put or call option whose
value would be added to the NPV of the investment.

Answers to End of Chapter Practice Problems

8.11 BigCo’s Chief Financial Officer is trying to determine a fair value for PrivCo, a non-publicly traded firm that BigCo’s is
considering acquiring. Several of PrivCo’s competitors, Ion International, and Zenon are publicly traded. Ion and Zenon have
price-to-earnings ratios of 20 and 15, respectively. Moreover, Ion and Zenon’s shares are trading at a multiple of earnings
before interest, taxes, depreciation, and amortization (EBITDA) of 10 and 8, respectively. BigCo estimates that next year
PrivCo will achieve net income and EBITDA of $4 million and $8 million, respectively. To gain a controlling interest in the
firm, BigCo expects to have to pay at least a 30% premium to the firm’s market value. What should BigCo expect to pay for
PrivCo?

a. Based on price-to-earnings ratios?

b. Based on EBITDA?

Answers:
a. $91 million
b. $93.6 million

a. (20 + 15) / 2 = 17.5

PV (based on P/E and incl. 30% premium) = 17.5 x $4 x 1.3 = $91
b. (10 + 8)/2 = 9
PV (based on EBITDA incl. 30% premium) = 9 x $8 x 1.3 = 93.6

8.12 LAFCO Industries believes that its two primary product lines, automotive and commercial aircraft valves, are rapidly becoming
obsolete. Its free cash flow is rapidly diminishing as it loses market share to new firms entering its industry. LAFCO has $200
million in debt outstanding. Senior management expects the automotive and commercial aircraft valve product lines to
generate $25 million and $15 million, respectively, in earnings before interest, taxes, depreciation, and amortization next year.
Senior management also believes that they will not be able to upgrade these product lines due to declining cash flow and
excessive current leverage. A competitor to its automotive valve business last year sold for 10 times EBITDA. Moreover, a
company that is similar to its commercial aircraft valve product line sold last month for 12 times EBITDA. Estimate LAFCO’s
breakup value before taxes.

Answer: $230 million

PV (automotive valves) = 25 x 10 = 250

PV (aircraft valves) = 15 x 12 = 180
Less outstanding debt = 200
Break-up value = 230

8.13 Siebel Incorporated, a non-publicly traded company, has 2009 after-tax earnings of $20 million, which are expected to grow at 5
percent annually into the foreseeable future. The firm is debt-free, capital spending equals the firm's rate of depreciation; and the
annual change in working capital is expected to be minimal. The firm's beta is estimated to be 2.0, the 10-year Treasury bond is 5
percent, and the historical risk premium of stocks over the risk-free rate is 5.5 percent. Publicly-traded Rand Technology, a direct
competitor of Siebel's, was sold recently at a purchase price of 11 times its 2009 after-tax earnings, which included a 20 percent
premium over its current market price. Aware of the premium paid for the purchase of Rand, Siebel's equity owners would like
to determine what it might be worth if they were to attempt to sell the firm in the near future. They chose to value the firm using
the discounted cash flow and comparable recent transactions methods. They believe that either method provides an equally valid.
Estimate of the firm's value.

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 a What is the value of Siebel using the DCF method?
b What is the value using the comparable recent transactions method?
c What would be the value of the firm if we combine the results of both methods?

Answers:
a. $228.8 million
b. $220 million
c. $224.4 million

a. COE = .05 + 2.0 (.055) = .16

PV = (20 x 1.05 / (.16-.05)) x 1.2 = 229.1
b. PV = 11 x 20 = $220
c. ($220 + $229.1) / 2 = $224.5

8.14 Titanic Corporation has reached agreement with its creditors to liquidate voluntarily its assets and to use the proceeds to pay off
as much of its liabilities as possible. The firm anticipates that it will be able to sell off its assets in an orderly fashion, realizing
as much as 70% of the book value of its receivables, 40% of its inventory, and 25% of its net fixed assets (excluding land).
However, the firm believes that the land on which it is located can be sold for 120% of book value. The firm has legal and
professional expenses associated with the liquidation process of $2,900,000. The firm has only common stock outstanding.
Estimate the amount of cash that would remain for the firm’s common shareholders once all assets have been liquidated.

Balance Sheet Item Book Value of Assets Liquidation Value

Cash $10
Accounts Receivable $20
Inventory $15
Net Fixed Assets $8
Excluding Land
Land $6
Total Assets $59
Total Liabilities $35
Shareholders Equity $24

Answer: $1.3 million

Balance Sheet Item Book Value of Assets Liquidation Value

Cash $10 $10
Accounts Receivable $20 $14
Inventory $15 $6
Net Fixed Assets, $8 $2.0
Excluding Land
Land $6 $7.2
Total Assets $59 $39.2
Total Liabilities $35 $35
Shareholders Equity $24 $4.2
Liquidation Related $.9 $2.9
Expenses
Cash Available for $1.3
Common Shareholders

8.15 Best’s Foods is seeking to acquire the Heinz Baking Company, whose shareholders equity and goodwill are $41 million and $7
million, respectively. A comparable bakery was recently acquired for $400 million, 30 percent more than its tangible book value
(TBV). What was the tangible book value of the recently acquired bakery? How much should Best’s Foods expect to have to
pay for the Heinz Baking Company? Show your work.

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 Answer: TBV of recently acquired bakery = $307.7 and likely purchase price of Heinz = $44.2 million.

Recall MVt /It = MVC / IC or It = MVt /(MVC / IC). Therefore, TBV = $400 / 1.3 = $307.7 million
Likely purchase price of Heinz Baking Company = MVt = (MVC / IC) x It = 1.3 x ($41-$7) = $44.2 million

8.16 Delhi Automotive Inc. is the leading supplier of specialty fasteners for passenger cars in the U.S. market, with an estimated 25
percent share of this $5 billion market. Delhi’s rapid growth in recent years has been fueled by high levels of reinvestment in the
firm. While this has resulted in the firm having “state of the art” plants, it has also resulted in the firm showing limited
profitability and positive cash flow. Delhi is privately owned and has announced that it is going to undertake an initial public
offering in the near future. Investors know that economies of scale are important in this high fixed cost industry and understand
that market share is an important determinant of future profitability. Thornton Auto Inc., a publicly traded firm and the leader in
this market, has an estimated market share of 38 percent and an $800 million market value. How should investors value the
Delhi IPO? Show your work.

Answer: $526.3 million. If the market leader has a market value and market share of $800 million and 38%, respectively, the
market is valuing each percentage point of market share at $21.05 million (i.e., $800 million/38). If Delhi has a market share of
25 percent, the IPO could have a potential value of $526.3 million (i.e., 25 points of market share times $21.05 million).

8.17 Photon Inc. is considering acquiring one of its competitors. Photon’s management wants to buy a firm it believes is most
undervalued. The firm’s three major competitors, AJAX, BABO, and COMET, have current market values of $375 million, $310
million, and $265 million, respectively. AJAX’s FCFE is expected to grow at 10 percent annually, while BABO’s and COMET’s
FCFE are projected to grow by 12 and 14 percent per year, respectively. AJAX, BABO, and COMET’s current year FCFE are
$24, $22, and $17 million, respectively. The industry average price-to-FCFE ratio and growth rate are 10 and 8%, respectively.
Estimate the market value of each of the three potential acquisition targets based on the information provided? Which firm is the
most undervalued? Which firm is most overvalued?

Answer: Ajax is most overvalued and Comet is most undervalued.

Industry average PEG ratio:10/8 = 1.25

Market Value of AJAX = 1.25 x 10 x $24 = $300 million
Market Value of BABO = .1.25 x 12 x $22 = $330 million
Market Value of COMET = 1.25 x 14 x $17 = $298 million
Current Market Value Estimated Market Value Difference
AJAX $375 $300 $75
BABO $310 $330 $(20)
COMET $265 $298 $(33)

8.18 Acquirer Incorporated’s management believes that the most reliable way to value a potential target firm is by averaging multiple
valuation methods, since all methods have their shortcomings. Consequently, Acquirer’s Chief Financial Officer estimates that
the value of Target Inc. could range, before an acquisition premium is added, from a high of $650 million using discounted cash
flow analysis to a low of $500 million using the comparable companies’ relative valuation method. A valuation based on a recent
comparable transaction is $672 million. The CFO anticipates that Target Inc.’s management and shareholders would be willing
to sell for a 20 percent acquisition premium, based on the premium paid for the recent comparable transaction. The CEO asks the
CFO to provide a single estimate of the value of Target Inc. based on the three estimates. In calculating a weighted average of
the three estimates, she gives a value of .5 to the recent transactions method, 3 to the DCF estimate, and .2 to the comparable
companies’ estimate. What it weighted average estimate she gives to the CEO? Show your work.

Answer: $690 million

Estimated Value Relative Weight Weighted Average

($ Millions) (As Determined by Analyst) ($ Millions)
672 .50 336.0
650 x 1.2 =780 .30 234.0
500 x 1.2= 600 .20 120.0

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 1.00 690.0

8.19 An investor group has the opportunity to purchase a firm whose primary asset is ownership of the exclusive rights to develop a
parcel of undeveloped land sometime during the next 5 years. Without considering the value of the option to develop the
property, the investor group believes the net present value of the firm is $(10) million. However, to convert the property to
commercial use (i.e., exercise the option), the investors will have to invest $60 million immediately in infrastructure
improvements. The primary uncertainty associated with the property is how rapidly the surrounding area will grow. Based on
their experience with similar properties, the investors estimated that the variance of the projected cash flows is 5% of the NPV,
which is $55 million, of developing the property. Assume the risk-free rate of return is 4 percent. What is the value of the call
option the investor group would obtain by buying the firm? Is it sufficient to justify the acquisition of the firm?

Answer: The value of the option is $13.47 million. The investor group should buy the firm since the value of the option more
than offsets the $(10) million NPV of the firm if the call option were not exercised.

Value of the underlying asset (Expected value of the property) (S) = $55 million
Exercise price (Upfront investment to commercialize the property) (E) = $60 million:
Variance in underlying asset’s value (Measure of cash flow risk) (σ2): .05
Time to expiration (t): 5
Risk free interest rate (R): 4

Where C = Theoretical call option value = SN(d1) – Ee-RtN(d2) = $55 x N(.6844) - $60 x 2.7183.04x5x N(.4920) =
$37.64 – $24.17 = $13.47 million.

d1 = ln(S/E) + R + (1/2)2t = ln($55/$60) + [.04 + (1/2).05]5 = -.0870 + .3250

t .05 5 ..2236 x 2.2361

= .2380 = .4760
.50

d2 = d1 - t = .4760 - .5 = -.0240

S = Stock price or underlying asset price

E = Exercise price
R = Risk free interest rate corresponding to the life of the option
2 = Variance of the stock’s or underlying asset’s returns
t = Time to expiration of the option
N(d1) and N(d2) = Cumulative normal probability values of d1 and d2
e = 2.7183

8.20 Acquirer Company’s management believes that there is a 60 percent chance that Target Company’s free cash flow to the firm
will grow at 20 percent per year during the next five years from this year’s level of $5 million. Sustainable growth beyond the
fifth year is estimated at 4 percent per year. However, they also believe that there is a 40 percent chance that cash flow will grow
at half that annual rate during the next five years and then at a 4 percent rate thereafter. The discount rate is estimated to be 15
percent during the high growth period and 12 percent during the sustainable growth period for each scenario. What is the
expected value of Target Company?

Answer: $94.93 million

PV20 = 5(1.20) + 5(1.2)2 + 5(1.2)3 + 5(1.2)4 + 5(1.2)5 + 5(1.2)5(1.04)/(.12-.04)

(1.15) (1.15)2 (1.15)3 (1.15)4 (1.15)5 (1.15)5

= 5.22 + 5.44 + 5.68 + 5.93 + 6.19 + 80.41 = 108.87

PV10 = 5(1.10) + 5(1.1)2 + 5(1.1)3 + 5 (1.1)4 + 5(1.1)5 + 5(1.1)5(1.04)/(.12-.04)

(1.15) (1.15)2 (1.15)3 (1.15)4 (1.15)5 (1.15)5

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 = 4.78 + 4.57 + 4.38 + 4.19 + 4.01 + 52.1 = 74.03

EV = .6 x 108.87 + .4 x 74.03 = 94.93

Solutions to End of Chapter Case Study Questions

Did British American Tobacco Overpay for Reynolds American?

Discussion Questions
1. Based on the information provided in Table 8.5, what do you believe is a reasonable standalone value for Reynolds? (Hint: Use
the comparable company valuation method to derive a single point estimate of standalone value.) Show your work.
Answer: $88.37 billion

Table 8.5 Valuing Reynolds American Using the Comparable Company Method
Comparable Company Target Valuation Based on Following Multiples (MVC/VIC)
Trailing P/E Forward P/E Average
Col. 1 Col. 2 Cols. 1-2
Philip Morris International 24.27 22.83
Imperial Brands 20.23 19.40
Swedish Match AB 17.98 16.05
Altria Group 18.35 17.78
Scandinavian Tobacco Group 21.28 20.64
Average Multiple (MVC/VIC) 20.42 19.34
Reynolds Value Indicators Dollars Per Share 4.26 4.64
(VIT)
Equals Estimated Market Value of Target ($ 87.0 89.73 88.37
Billions)
Source: Yahoo Finance

2. Does your answer to question (1) include a purchase price premium? Explain your answer.
Answer: Answer: No. The use of the comparable companies' valuation methodology provides an estimate of the standalone value
of each competitor as a going concern and does not include an estimated premium. That is, the valuation reflects a firm's value
as if it were valued as a going concern and not subject to takeover.

3. What are the key limitations of the comparable companies' valuation methodology? Be specific.
Answer: The comparable company method measures the value of the target firm at a moment in time. In the current (as of
this writing) artificially low interest rate environment, P/E multiples tend to be overstated. Why? Abnormally low interest rates
drive investors to search for higher financial returns in risky assets such as stocks. Consequently, investors bid up the price of
stocks relative to their earnings. Furthermore, the choice of multiples to use can be highly subjective. Finally, it is difficult to
find firms that are truly comparable to the target firm in that they should have profitability, growth and risk characteristics that
correlate well with those of the target firm.

4. In estimating the value of anticipated cost savings, should an analyst use Reynolds marginal tax rate of 40% or its effective tax
rate of 22%? Explain your answer.
Answer: Note that the marginal tax rate rather than the effective tax rate is used to reflect the eventual repayment of tax
deferrals. Using the effective tax rate which is lower than the firm's marginal rate implies that deferred taxes or the difference
between the statutory and effective rates will never be paid to the tax authorities.

5. What is the 2018 after-tax present value of the $400 million pre-tax annual cost savings expected to start in 2019? Assume the
appropriate cost of capital is 10% and that the savings will continue in perpetuity. Show your work.
Answer: The $400 million in pretax cost savings is expected to be realized beginning in 2020 or 2 years after closing. Assuming
a cost of capital of 10%, the PV of synergy after taxes in perpetuity beyond 2020 is $2.4 billion (i.e., $.4 x (1 - .4)/.10). The PV
of $2.4 billion in 2018 is 1.86 billion. The current PV of synergy can be written as follows:
PV(synergy) = {$.40 billion x (1 - .4) / .10}/ (1 + .10)2 = $2.40 billion / 1.21= $1.98 billion.

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6. What are the key valuation assumptions underlying the valuation of Reynolds? Include both the valuation of Reynolds as a
standalone business and synergy value. Be specific.
Answer: With respect to the standalone valuation, it is assumed that the valuation multiples are appropriate and that the
firms selected for the peer group are very similar to Reynolds in terms of profitability, growth and risk. In addition, it is assumed
that the valuation multiples are not biased by factors such as abnormally low interest rates at the time of the valuation. With
respect to the valuation of synergy, it is assumed that the cost of capital is 10%; the appropriate tax rate is 40%; the annual cost
savings are realized as expected; and that the cost savings continue in perpetuity.

7. What is the maximum amount BAT could have paid for Reynolds and still earned its cost of capital? Recall that BAT acquired
the remaining 57.8% of Reynolds that it did not already own. Did BAT overpay for Reynolds based on the information given in
the case? Explain your answer. (Hint: Use your answers to questions (1) and (5))
Answer: BAT acquired the remaining 57.8% of Reynolds that it did not already own. Consequently, it acquired 57.8% of
Reynolds's standalone value of $88.37 billion or $51.08 billion. The maximum purchase price is $51.08 billion plus present value
of synergy of $1.98 billion or $53.06. The actual purchase price paid for 57.8% was $49.4 billion, which is less than the
maximum purchase price. Therefore, BAT did not overpay for Reynolds based on the valuation methods and assumptions
employed and should earn its cost of capital.

Examination Questions and Answers

True and False Questions: Answer true or false to the following questions:

1. The comparable companies’ valuation method uses the discounted value of a firm’s free cash flow. True or False
Answer: False

2. The comparable recent transactions method is usually considered less reliable than the comparable companies’ valuation method.
True or False
Answer: False

3. If the market leader in an industry has a $300 million market value and a 30% market share, the market is valuing each
percentage point of market share at $10 million. If a target company in the same industry has a 20% market share, the market
value of the target company is $200 million. True or False
Answer: True

4. Liquidation value is the projected sale value of a firm’s assets. True or False
Answer: False

5. If the tangible book value of a firm significantly exceeds its market value for an extended period of time, it can become an
attractive takeover target. True or False
Answer: True

6. Valuations of target firms based on the comparable companies and recent transactions methods must be adjusted to reflect
control premiums. True or False
Answer: False

7. The replacement cost approach to valuation of a target firm ignores value created by operating the assets in combination as a
going concern. True or False
Answer: True

8. Tangible book value is the value of shareholders’ equity less net fixed assets. True or False
Answer: False

9. Break-up value assumes that individual businesses can be sold quickly without any material loss of value. True or False
Answer: True

10. Liquidation value provides an estimate of the minimum value of the target firm. True or False

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 Answer: True

11. The capitalization rate is equivalent to the discount rate when the firm’s revenues are not expected to grow. True or False
Answer: True

12. Book values are maligned as measures of value, because they represent historical rather than current market values. True or
False
Answer: True

13. The principal limitation to the comparable companies’ valuation approach is the difficulty in finding companies that are truly
comparable to the target firm. True or False
Answer: True

14. Price-to-earnings ratios of comparable companies provide an excellent means of valuing the target firm at any point in the
business cycle. True or False
Answer: False

15. Market-based valuation measures are meaningful only for firms with a stable earnings, cash flow, or sales history. True or False
Answer: True

16. Asset oriented approaches to valuation involve the use of tangible book value, liquidation value, discounted cash flows, and
break-up values. True or False
Answer: False

17. The weighted average valuation approach involves the use of a number of different valuation methods, weighted by the relative
importance the appraiser attributes to each method. True or False
Answer: True

18. Relative valuation methods are often described as market-based, as they reflect the amounts investors are willing to pay for each
dollar of earnings, cash flow, sales, or book value at a moment in time. True or False
Answer: True

19. If the P/E ratio for the comparable firm is equal to 10 and the after-tax earnings of the target firm are $2 million, the market value
of the target firm would be $5 million. True or False
Answer: False

20. The use of market-based valuation methods usually reflect actual demand and supply considerations at a moment in time. True
or False
Answer: True

21. The comparable companies’ method is widely used in so-called “fairness opinion” letters. True or False
Answer: True

22. The comparable companies’ transactions valuation method is generally considered the most accurate of all the valuation
methods. True or False
Answer: False

23. The value of the comparable companies’ method may vary widely depending upon when it is calculated in the business cycle.
True or False
Answer: True

24. Like the recent transactions method, comparable company valuation estimates do not require the addition of a purchase price
premium. True or False
Answer: False

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25. Market-based valuation methods are less prone to manipulation than discounted cash flow methods because they require a more
detailed statement of assumptions. True or False
Answer: False

26. The analyst should be careful not to mechanically add an acquisition premium to the target firm’s estimated value based on the
comparable companies’ method if there is evidence that the market values of these “comparable firms” already reflect the effects
of acquisition activity elsewhere in the industry. True or False
Answer: True

27. Studies show that rival firms’ share prices will rise in response to the announced acquisition of a competitor, regardless of
whether the proposed acquisition is ultimately successful or unsuccessful. True or False
Answer: True

28. The comparable companies’ method and recent transactions methods of valuation are conceptually similar. True or False
Answer: True

29. Disadvantages of the comparable industry method of valuation include the presumption that industry multiples are actually
comparable and that analysts’ earnings projections are unbiased. True or False
Answer: True

30. Analysts have increasingly used the relationship between enterprise value to earnings before interest and taxes, depreciation, and
amortization to value firms. True or False
Answer: True

31. The enterprise value to EBITDA multiple relates the total book value of the firm from the perspective of the liability side of the
balance sheet (i.e., long-term debt plus preferred and common equity), excluding cash, to EBITDA. True or False
Answer: False

32. In constructing the enterprise value, the market value of the firm’s common equity value is added to the market value of the
firm’s long-term debt and the market value of preferred stock. True or False
Answer: True

33. The enterprise value to EBITDA method is useful because more firms are likely to have negative earnings than negative
EBITDA. True or False
Answer: True

34. The enterprise to EBITDA method of valuation can be compared more readily among firms exhibiting different levels of
leverage than for other measures of earnings, since the numerator represents the total value of the firm and the denominator
measures earnings before interest. True or False
Answer: True

35. A higher P/E ratio for a firm may be justified if its earnings are expected to grow significantly faster than firm’s future earnings.
True or False
Answer: True

36. The so-called PEG ratio is calculated by dividing the firm’s price-to-earning ratio by the expected growth rate in the firm’s share
price. True or False
Answer: False.

37. Conceptually, firms with P/E ratios less than their projected growth rates may be considered undervalued; while those with P/E
ratios greater than their projected growth rates may be viewed as overvalued. True or False
Answer: True

38. It is critical for the analyst to remember that high growth rates by themselves are likely to increase multiples such as a firm’s
price to earnings ratio even without any improvement in financial returns. True or False
Answer: False

10
39. Investors may be willing to pay considerably more for a stock whose PEG ratio is greater than one if they believe the increase in
earnings will result in future financial returns that significantly exceed the firm’s cost of equity. True or False
Answer: True

40. Empirical evidence suggests that forecasts of earnings and other value indicators are better predictors of firm value than value
indicators based on historical data. True or False
Answer: True

41. The PEG ratio can be helpful in evaluating the potential market values of a number of different firms in the same industry in
selecting which may be the most attractive acquisition target. True or False
Answer: True

42. In the absence of earnings, other factors that drive the creation of value for a firm may be used for valuation purposes. True or
False
Answer: True

43. Macro value drivers are those factors which directly influence specific activities within the firm. True or False
Answer: False

44. The number of billing errors as a percent of total invoices is a specific example of a macro value driver. True or False
Answer: False

45. Micro value drivers are those factors affecting specific functions within the firm. True or False
Answer: True

46. The major advantage of the value driver approach to valuation is the implied assumption that a single value driver or factor is
representative of the total value of the business. True or False
Answer: False

47. Tangible book value is widely used for valuing financial services companies, where tangible book value is primarily cash or
liquid assets. True or False
Answer: True

48. Liquidation or breakup value is the projected price of the firm’s assets sold separately in liquidating or breaking up the firm.
True or False
Answer: False

49. When estimating liquidation value, analysts often make a simplifying assumption that the assets can be sold in an orderly
fashion, which is defined as a reasonable amount of time to solicit bids from qualified buyers. True or False
Answer: True

50. In determining the liquidation value of inventories, it is not necessary to look at their composition. True or False
Answer: False

51. The replacement cost approach to valuation estimates what it would cost to replace the target firm’s
assets at current market prices using professional appraisers less the present value of the firm’s
liabilities. True or False
Answer: True

52. Valuing the assets separately in terms of what it would cost to replace them may seriously overstate
the firm’s true going concern value. True or False
Answer: False

11
53. An option is the exclusive right, but not the obligation, to buy, sell, or use property for a specific period of time in exchange for a
predetermined amount of money. True or False
Answer: True

54. Real options include the right to buy land, commercial property, and equipment. Such assets can be valued as call options if its
current value exceeds the difference between the asset’s current value and some predetermined level. True or False
Answer: True

55. Real options, also called strategic management options, refer to management’s ability to adopt and later revise corporate
investment decisions. True or False
Answer: True

56. Since real options provide flexibility that can greatly change the value of a project, it should be considered in capital budgeting
methodology. True or False
Answer: True

57. Investment decisions, including M&As, often contain certain “embedded options” such as the ability to accelerate growth by
adding to the initial investment (i.e., expand), to delay the timing of the initial investment (i.e., delay), or to walk away from the
project (i.e., abandon). True or False
Answer: True

58. The NPV of an acquisition of a manufacturer operating at full capacity may have a lower value than if the NPV is adjusted for a
decision made at a later date to expand capacity. If the additional capacity is fully utilized, the resulting higher level of future
cash flows may increase the acquisition’s NPV. In this instance, the value of the real option to expand is the difference between
the NPV with and without expansion. True or False
Answer: True

59. All investment decisions include clearly identifiable and measurable real options whose estimated value should be included in
the valuation of the opportunity. True or False
Answer: False

60. An option to abandon an investment (i.e., divest or liquidate) will often increase the NPV because of its effect on reducing risk.
By exiting the business, the acquirer may be able to recover a portion of its original investment and truncate projected negative
cash flows associated with the acquisition. True or False
Answer: True

Multiple Choice Questions

1. Which one of the following factors is not considered calculating a firm’s PEG ratio?
a. Projected growth rate of the value indicator (e.g., earnings)
b. Ratio of market price to value indicator (e.g., P/E)
c. Share exchange ratio
d. Historical growth rate of the value indicator
e. None of the above
Answer: C

2. In determining the purchase price for an acquisition target, which one of the following valuation methods does not require the
addition of a purchase price premium?

a. Discounted cash flow method

b. Comparable companies’ method
c. Comparable industries’ method
d. Recent transactions’ method
e. A & B only
Answer: D

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3. Limitations in applying the comparable companies’ method of valuation include which of the following?

a. Finding truly comparable companies is difficult

b. The use of market-based methods can result in significant under- or overvaluation during periods of declining or rising
stock markets
c. Market-based methods can be manipulated easily, because the methods do not require a clear statement of assumptions
with respect to risk, growth, or the timing or magnitude of future earnings and cash flows.
d. A, B, & C
e. A & B only
Answer: D

4. Which of the following represent options available to managers in making investment decisions?

a. Delay initial investment

b. Accelerate cumulative investment
c. Abandon the investment at a later date
d. A & B only
e. A, B, & C
Answer: E

5. Which one of the following is not a commonly used method of valuing target firms?

a. Discounted cash flow

b. Comparable companies method
c. Recent transactions method
d. Asset oriented method
e. Share exchange ratio method
Answer: E

6. Which of the following is not true about real options?

a. All investment decisions contain identifiable and measurable real options.
b. Under certain circumstances, management may be able to delay their initial investment in a project or M&A.
c. Real options may be valued as the expected value of various alternative cash flow projections.
d. Real options can be valued using the Black-Sholes method.
e. None of the above
Answer: A

7. Which of the following represent limitations of real options?

a. Key assumptions often are very difficult to quantify, especially volatility

b. Project delays may incur significant opportunity costs
c. Options often are not independent; therefore, selecting one option may foreclose other options
d. Often requires complex modeling
e. All of the above
Answer: E

8. Which of the following statements about the comparable companies’ valuation method is not true?

a. Requires the use of firms that are “substantially” similar to the target firm
b. Uses market based rather than cash flow based valuations
c. Often used as the basis of investment banker fairness opinions
d. Generally provides the most accurate valuation method
e. Provides an estimate of the target firm at a moment in time.
Answer: D

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9. The tangible book value or equity per share method is applicable primarily to the following industries:

a. Steel and financial services

b. Distribution and financial services
c. Electric and natural gas utilities
d. Coal and copper mining
e. Space and defense
Answer: B

10. Which of the following is not true about the liquidation/break-up valuation methods?

a. Highly diversified companies are often valued in terms of the sum of the standalone values of their operating units
b. The calculation of such values is heavily dependent on the skill of appraisers who are intimately familiar with the
operations to be liquidated.
c. Assets can sometimes be liquidated in an orderly fashion.
d. Legal, appraisal, and consulting fees may comprise a substantial share of the total proceeds of the sale of the assets
e. The liquidation value of most of the firm’s assets is about the same.
Answer: E

11. Intangible assets often constitute a substantial source of value to the acquiring firm. Which of the following are not generally
considered intangible assets?

a. Patents and technical know-how

b. Warranty and contingent claims
c. Trademarks and customer lists
d. Covenants not to compete and franchises
e. Copyrights and software
Answer: B

12. Which of the following represent advantages of the comparable companies’ valuation method?

a. Uses the most accurate market-based valuation at a point in time

b. Valuations need to be adjusted to reflect control premiums
c. Adjusts for risk of future cash flows
d. Adjusts for the timing of future cash flows
e. A & B only
Answer: A

13. Which of the following is not generally considered a valuation method?

a. Discounted cash flow method

b. Comparable companies’ method
c. Share exchange ratio method
d. Liquidation value method
e. Comparable transaction’s method
Answer: C

14. All of the following are true for market based valuation methods except for which of the following?

a. Assumes that markets are efficient such that current values reflect all the information currently known about the
business
b. Current values represent what a willing buyer and seller are willing to pay for a business in the absence of full
information
c. Market based methods are always superior to discounted cash flow techniques
d. Include comparable company and recent transactions methods
e. Include the tangible book value approach

14
 Answer: C

15. Which of the following are examples of intangible assets that may have value to the acquiring company?

a. Patents
b. Trade names
c. Customer lists and relationships
d. Covenants not to compete
e. All of the above
Answer: E

Case Study Short-Essay Examination Questions

MANAGING COKE'S NATURAL DRINK BUSINESS PORTFOLIO

______________________________________________________________
KEY POINTS
 DCF and relative valuation methods suggest implicitly that once an investment decision has been made there is little opportunity
for management to change the outcome.
 In practice, management often has considerable flexibility to accelerate, delay, or abandon the original investment as new
information is obtained.
 Recognizing the need for flexibility in decision making, partial takeovers often include a mechanism (so-called "real options")
for expanding or exiting an investment.
_____________________________________________________________________________
Faced with a maturing soda market, Coca-Cola (Coke) has sought to broaden its brand offering portfolio. To this end, the firm has taken
ownership stakes varying in amount in a variety of companies whose brands offer greater growth potential than its core product line. The
firm’s strategy is to find promising new brands and then test the firm’s potential by making a minority ownership investment. Coke has
previously invested in Monster Beverage Corp, the energy drink company, and Keurig Green Mountain Inc. which sells single serving
coffee pods. Coke already owns Odwalla, Honest Tea, and Zico Coconut Water.

In an investment consistent with this strategy, Coke announced on August 19, 2015 that it had invested $90 million for a 30%
ownership position in Suja Life LLC (Suja) along with Goldman Sach’s (Goldman) merchant banking subsidiary which had invested $60
million for a slightly smaller stake in Suja. The combined $150 million investment gives the two investors slightly less than 50%
ownership of Suja’s outstanding equity. The deal also gives Coke an option to require the remainder of the company at a predetermined
price within three years. As part of the deal, Coke will expand Suja’s distribution and provide funds to build a new factory. The deal will
help boost the number of locations that sell Suja by 50% by late 2016. Coke also will use its procurement network to buy raw materials at
a lower cost.

Health drink brand, Suja, whose juices include combinations such as strawberry and flax seed, has posted rapid revenue growth since
its startup in early 2012, with its sales doubling each year since then to more than $43 million in 2014. New juice brands are benefitting
from consumers turning away from sugary brands of soda. For Suja, the deal has been highly controversial as many of its customers are
concerned that Coke will cause the firm to stray from what makes it unique and socially responsible. Suja avoids using genetically
modified organisms, or GMOs, and donates a portion of its sales to environmental causes. Some customers stopped purchasing the
product in protest.

The risk to Coke and Goldman Sachs is clear: Does Suja’s meteoric revenue growth rate have staying power? Currently, Suja’s
products are a niche market and as many such products could be destined to fade as fickle consumers lose interest. Moreover, the
association with Coke could cause the current unrest among Suja customers to grow. These factors could substantially reduce Suja’s
value. Given these uncertainties what future options do Coke and Goldman have?

Real options differ from strategic options in that they are available to management after an investment is made. In practice, Coke’s
management could accelerate investment in Suja if revenue and profit growth rates justify it by exercising its option to buy the 50% of the
shares it and Goldman do not currently own. Goldman could participate by providing a portion of the additional funds needed to buy out
the remaining Suja shareholders. If the firm’s growth slows appreciably, the option could be allowed to expire. Finally, Coke and

15
Goldman could abandon their investment by spinning-off or divesting their minority positions. While expensive potentially, the latter
option allows the investors to limit future losses.

INVESTORS QUESTION ABBOTT LABS' VALUATION

OF ST. JUDE'S MEDICAL

Case Study Objectives: To Illustrate

 The application of relative valuation methods,
 The limitations of such methods,
 How to approximate the value of synergy, and
 The role key assumptions play in establishing the credibility of any valuation.

Abbott Lab's market value plunged more than $5 billion or six percent in a single day following the announcement of the firm's
acquisition of St. Jude Medical (St. Jude) on April 26, 2016, as investors expressed their disapproval. Their concern was that Abbot was
overpaying and would be unable to earn financial returns demanded by investors. The $25 billion deal included a $6.5 billion premium,
37% above St. Jude's closing price on April 25, 2016. St. Jude's shares soared by more than 27% boosting the firm's market capitalization
to $24.1 billion from its level of $17.59 billion the prior day.

In announcing the transaction, Abbott said the primary motive for the takeover was to expand its heart device business. Abbott, the
industry leader in manufacturing coronary stents and heart valves, wanted to combine with St. Jude, a maker of pacemakers and other
devices for failing hearts. The aging population makes the "failing heart" market likely to show considerable growth in the coming years.
Medical equipment makers are under pressure to offer a wider portfolio of products to their hospital customers, which have been
through a wave of mergers that have increased their power to negotiate pricing. With combined revenue of $8.7 billion, Abbott said its
deal would help it compete more effectively against larger rivals Medtronic Plc, Boston Scientific Corp, and Edward Life Sciences. The
combination of Abbott and St. Jude creates a medical device manufacturer with leading positions in high growth cardiovascular markets,
including atrial fibrillation, structural heart and heart failure, as well as a leading position in the high growth neuromodulation market.
The new firm also will have the largest pipeline (products in development) to deliver a steady stream of new medical devices to these high
growth markets.

The definitive agreement reached by Abbott and St. Jude called for St. Jude shareholders to receive $46.75 in cash and .8708 shares of
Abbott common stock. This represented a total consideration of $85 per share. Abbott expects the deal would be accretive to earnings per
share and that the combined firm will earn double-digit financial returns within 5 years. Management expects annual pre-tax cost savings
of $500 million to begin within five years following closing. For the firm to earn the returns promised by management, it must be able to
realize expected annual pretax cost savings beginning in 2020. Failure to realize these expected savings in a timely manner can impact
significantly synergy value. Also, it is unclear if the full cost of realizing these synergies has been deducted from the projected savings.

One way of determining if Abbott is overpaying is to estimate St. Jude's standalone value plus the present value of anticipated synergy.
This estimate represents the upper limit (maximum) for the amount Abbott should pay for St. Jude and still be able to earn its cost of
capital. Any payment in excess of the maximum purchase price means that Abbott is destroying shareholder value by in effect
transferring more value than would be created to the target firm shareholders.

Table 8.5 provides data enabling an analyst to value St. Jude on a standalone basis using the comparable company method. Note that
the table contains valuation multiples for St. Jude's three primary competitors as well as earnings, revenue, book value and enterprise
value per share for St. Jude. The choice of valuation multiples is subjective in that it is unclear which best mirror the standalone value of
St. Jude's. Abnormally low interest rates at the time of the merger announcement could have resulted in artificially high valuation
multiples. Also, the competitors selected are larger and more diversified than St. Jude's and their growth rates and profitability tend to be
greater while the riskiness of their cash flows tends to be less.

Table 8.5 St. Jude Medical Valuation Data

Forward P/Ea Price / Price/Bookc Enterprise Enterprise
Revenueb Value to Value to
EBITDA Revenue

16
 Col. 1 Col. 2 Col. 3 Col. 4 Col. 5
Primary Competitors
Medtronic (Ratio) 16.14 4.17 2.32 15.19 4.69
Boston Scientific 18.04 4.10 4.82 18.41 4.70
(Ratio)
Edward Life Sciences 29.28 4.87 9.13 26.77 4.99
(Ratio)
St. Jude Medical Earnings Per Annual Book Value / Enterprise Annual
(Dollars Per Share) Share Revenue / Share Value / Revenue /
Share Share Share
$1.06 $5.54 $4.04 $1.12 $5.54
a
S&P Capital IQ report Consensus Estimate (4/26/16)
b
Trailing 52 week average from S&P Capital IQ for period ending March 31, 2016.
c
Most recent quarter (April 2, 2016)

Discussion Questions and Answers:

1. Based on the information provided in Table 8.5, what do you believe is a reasonable standalone value for St. Jude Medical?
(Hint: Use the comparable company valuation method to derive a single point estimate of standalone value.)
Answer:
Table 8.5 Valuing St. Jude Medical Using the Comparable Company Method
Target Valuation Based on Following Multiples (MVC/VIC)
Comparable Company Forward Price / Price Enterprise Enterprise Average
P/Ea Revenueb /Bookc Value to Value to
EBITDA Revenue
Col. 1 Col. 2 Col. 3 Col. 4 Col. 5 Cols. 1-5
Medtronic 16.14 4.17 2.32 15.19 4.69
Boston Scientific 18.04 4.10 4.82 18.41 4.70
Edward Life Sciences 29.28 4.87 9.13 26.77 4.99
Average Multiple 21.15 4.38 5.42 20.12 4.79
(MVC/VIC)
St. Jude Value 1.06 5.54 4.04 1.12 5.54
Indicators Dollars Per
Share (VIT)
Equals Estimated 22.42 24.27 21.90 22.53 26.54 23.53
Market Value of
Target ($Billions)d
a
S&P Capital IQ Report Consensus Estimate (4/26/16)
b
Trailing 12 month average
c
Most recent quarter (April 2, 2016)
d
Billions of dollars. Average multiple (MVC/VIC) x St. Jude value indicator expressed in dollars per share (VIT). For
example, using the forward P/E earnings multiple times St. Jude projected earnings per share = 21.15 x $1.06 =
$22.42 billion.

2. Does your answer to question (1) include a purchase price premium? Explain your answer.

Answer: No. The use of the comparable companies' valuation methodology provides an estimate of the standalone value of
each competitor as a going concern and does not include an estimated premium. That is, the valuation reflects a firm's value as if
it were valued as a going concern and not subject to takeover.

3. What are the key limitations of the comparable companies' valuation methodology? Be specific.

Answer: The comparable company method measures the value of the target firm at a moment in time. In the current (as of
this writing) artificially low interest rate environment, P/E multiples tend to be overstated. Why? Abnormally low interest rates

17
 drive investors to search for higher financial returns in risky assets such as stocks. Consequently, investors bid up the price of
stocks relative to their earnings. Furthermore, the choice of multiples to use can be highly subjective. Finally, it is difficult to
find firms that are truly comparable to the target firm in that they should have profitability, growth and risk characteristics that
correlate well with those of the target firm.

4. In estimating the value of anticipated cost savings, should the analyst use St. Jude's marginal tax rate of 40% or its effective tax
rate of 22%? Explain your answer.

Answer: Note that the marginal tax rate rather than the effective tax rate of 22% is used to reflect the eventual repayment of tax
deferrals. Using the effective tax rate which is lower than the firm's marginal rate implies that deferred taxes or the difference
between the statutory and effective rates will never be paid to the tax authorities.

5. What is the present value of the $500 million pre-tax annual cost savings expected to start in 2020? Assume the appropriate cost
of capital is 10% and that the savings will continue in perpetuity. Show your work.

Answer: The $500 million in pretax cost savings is expected to be realized beginning in 2020 or 5 years after closing. Assuming
a cost of capital of 10%, the PV of synergy in perpetuity beyond 2020 is $3.0 billion (i.e., $.5 x (1 - .4)/.10). The PV of $3.0
billion in 2016 is 1.86 billion. The current PV of synergy can be written as follows:
PV(synergy) = {$.50 billion x (1 - .4) / .10}/ (1 + .10)5 = $3.00 billion / 1.61= $1.86 billion

6. What are the key valuation assumptions underlying this valuation of St. Jude Medical? Be specific.

Answer: With respect to the standalone valuation, it is assumed that both the valuation multiples are appropriate and that the
firms selected for the peer group are very similar to St. Jude in terms of profitability, growth and risk. In addition, it is assumed
that the valuation multiples are not biased by factors such as abnormally low interest rates at the time of the valuation. With
respect to the valuation of synergy, it is assumed that the cost of capital is 10%; the appropriate tax rate is 40%; the annual cost
savings are realized as expected; and that the cost savings continue in perpetuity.

7. What is the maximum amount Abbott Labs could have paid for St. Jude's Medical and still earned its cost of capital? Did Abbott
overpay for St. Jude? Explain your answer.

Answer: St. Jude's standalone value plus the after tax value of anticipated synergy = $23.53 (see answer to question 1) + $1.86
(see answer to question 5) = $25.39. The maximum purchase price exceeds what Abbott paid by $.39 billion and therefore
Abbott is able will earn its cost of capital.

VALUING THE TWITTER IPO

Case Study Objectives: To Illustrate

 Valuation is far more an art than a science.
 Understanding the limitations of individual valuation methods is critical.
 Averaging multiple valuation methods is often the most reliable means of valuing a firm.
 The credibility of any valuation ultimately rests on the credibility of its key underlying assumptions.

In the now infamous “dotcom” era, firms like Yahoo, Lycos, Excite and others evolved into portals in a desperate attempt to find ways to
make money from providing users the ability to search the web. Enter Google and the competitive landscape changed quickly. Google
invented the concept of paid search and contextual, pay-to-click advertising models.

Today, social networks like Twitter and Facebook, while attracting new users at an astonishing pace, have not fully defined their
business models. In fact, the eventual winners in the social networking space may not even exist today. Nonetheless, investor expectations

18
for the growth potential of social networking firms remained very optimistic during 2013. This investor enthusiasm prompted Twitter’s
financial backers and founders to take the firm public late in 2013, at a time when the firm’s valuation was likely to be high.

Twitter got its start in 2006, first with Jack Dorsey and then Evan Williams as CEO. In 2013, its CEO was Dick Costolo, a former
Google executive, steered the firm through one of the most exciting times in the firm’s young life. Since its inception, the social network
that lets users send short messages or “tweets” 140 characters in length has attracted world leaders, religious icons, and celebrities as well
as CEOs, marketers, and self-promoters. Twitter at the time of the IPO had 230 million users with three quarters outside the U.S.

In early 2013, Twitter had a valuation based on the sales of shares by employees to BlackRock, a multinational investment
management corporation, of $9 billion. According to pre-IPO leaks, hedge funds in the months immediately prior to the IPO in late 2013
were offering to pay $28 per privately traded shares, setting a $14 billion valuation for the entire firm.

Per the IPO prospectus, Twitter’s projected revenue from advertising in 2013 was $600 million based on what Twitter call “promoted
Tweets.” Revenue projections for 2014 were $1 billion. Using this information, investors in anticipation of the November 6, 2013 IPO
turned to estimating the market value of Twitter based on comparable publicly traded firms. Firms believed to be similar to Twitter were
those in the social networking space and which seemed to display similar growth, risk and profitability characteristics. As is often the
case, there were no firms that were both publicly traded and truly similar in size, product offering, and which satisfied the same customer
needs. Investors used valuation multiples for Facebook, LinkedIn, and Yelp as Twitter’s foremost peers.

Without detailed financial statements, investors groped for rudimentary valuation estimates based simply on revenue, the easiest metric
to find. Just prior to the IPO, Facebook traded at 18 times estimated 2013 sales. LinkedIn and Yelp traded for about 22 and 23 times
estimated 2013 sales, respectively. Multiples of projected 2014 revenue just prior to the Twitter IPO were 11, 14, and 13 times revenue
for Facebook, LinkedIn, and Yelp, respectively.

Since the firm was expected to lose $(.11) per share in 2013 and $(.02) in 2014, Twitter could not be valued based on estimates of
earnings per share or similar profitability measures. However, it could also be valued based on enterprise value as a multiple of earnings
before interest, depreciation, and amortization (EBITDA). For most firms, EBITDA is positive and often is used as a proxy for cash flow.
Enterprise value (EV) includes the market value of equity and debt less cash on the balance sheet. The appropriate valuation multiple was
calculated by computing the ratio of EV to EBITDA. Using this valuation multiple, Facebook traded at a ratio of 36 and LinkedIn at 159
for 2014. Yelp, with a negative EBITDA for 2013, did not have a meaningful enterprise to EBITDA ratio. Twitter’s estimated EBITDA
for 2013 was $230 million and $260 million in 2014.

These valuation multiples implied a very high valuation (market capitalization) and price per share for the IPO. But investors remained
cautious, as valuation estimates too often prove wrong. For every successful IPO like LinkedIn, there is a Groupon or Zynga that were
duds. Groupon, the provider of online discount coupons, went public in November 2011 at $20 per share. After accounting
investigations, slowing growth and a CEO firing, its shares traded at $11.50 at the time of the Twitter IPO. Online game maker Zynga,
which went public at $10 a share around the same time as Groupon, was unable to fully adjust as its users went mobile and now trades at
$3 per share. Facebook’s valuation at the time of its IPO on May 17, 2012 was $109 billion. Facebook then saw its valuation fall by 50
percent in the months immediately following the IPO. Its shares now trade well above its IPO price of $38 per share.

Moreover, Twitter’s user growth had slowed giving investors another reason to be cautious. After hitting 200 million monthly active
users at the end of 2012, the firm set a goal of 400 million by the end of 2013. At the time of the IPO, active users numbered a far more
modest 240 million.

Investors also had reason to question how similar Twitter actually was to its presumed peers. For example, the differences between
Twitter and Facebook are enormous in that they purport to satisfy substantially different user needs. Twitter is focused and simple while
Facebook offers users a portal interface. Facebook appeals to people looking to reconnect with friends and family or find new friends
online and offers email, instant messaging, image and video sharing. Most people can grasp how to use Facebook quickly. In contrast, the
usefulness of Twitter is not as obvious to some people as Facebook, although it may be more addictive since you get immediate
responses. Users often say they like Twitter because they can get instant responses to a question or comment.

The actual value of the IPO depended on whether investors used basic shares outstanding or fully diluted shares. Twitter ended the first
day of the IPO at $44.90 a share based on the number of basic shares outstanding (excluding options and restricted shares). Unlike the
Facebook IPO, the Twitter IPO went off without a hitch. This valued the firm at $24.9 billion. This valuation is based on 555 million
shares outstanding. The basic share count excludes options, warrants, and restricted stock. Altogether, Twitter has 150 million such shares

19
according to the IPO filing bringing the total share count to 705 million. Failure to include these shares can result in investors ignoring
their impact on dilution of EPS and ownership stake. Such investors pay more than they should.

Another adjustment must be made in calculating fully diluted shares outstanding for options and warrants. When options and warrants
are exercised by their holders, Twitter received cash equal to the number of options multiplied by their weighted average exercise price.
For the purpose of analysis, investors, typically assume a firm will reinvest the combined proceeds from the exercise of options and
warrants into buying back shares. This lowers Twitters diluted share count slightly to 704 million.

Based on fully diluted shares outstanding of 704 million shares, the IPO price per share of $44.90 placed the value of the IPO at $31.6
billion (i.e., 704 x $44.90), $6.7 billion more than the $24.9 billion valuation based only on basic shares outstanding. Using the basic
market capitalization, Twitter was valued at 24.9 times 2014 sales estimates (i.e., $24.9 billion in market value/$1 billion in revenue).
Using fully diluted shares outstanding, the multiple rises to 31.6 times (i.e., $31.6 billion in market value/$1 billion in revenue). That gap
should close over time since firms like Twitter tend to issue fewer options and restricted stock following the IPO.

Discussion Questions
1. Based on the information given in the case, how would you estimate the value of Twitter at the time of the IPO based on a simple
average of comparable firm revenue multiples based on projected 2014 revenue?

Answer: Multiples of projected 2014 revenue just prior to the Twitter IPO were 11, 14, and 13 times revenue for Facebook, LinkedIn,
and Yelp, respectively. Projected 2014 Twitter revenue was $1 billion. Therefore, the implied valuation of Twitter based on the
simple average of peer firm multiples is (i.e., $1 billion x (11+14+13)/3 = $12.33 billion.

2. Based on the information given in the case, how would you estimate the value of Twitter at the time of the IPO based on a simple
average of comparable firm enterprise to EBITDA multiples based on projected 2014 EBITDA?

Answer: Facebook’s enterprise to EBITDA ratio based on projected 2014 EBITDA was 36 and LinkedIn was 159. Twitter’s
projected 2014 EBITDA at the time of the IPO was260 million. Therefore, Twitter’s valuation based on projected 2014 EBITDA at
the time of the IPO was $25.35 billion (i.e., $260 million x (36 + 159)/2).

3. The valuation estimates in the preceding two questions are substantially different. What are the key assumptions underlying each
valuation method? Be specific. How can an analyst combine the two valuation estimates assuming she believes that the enterprise to
EBITDA ratio is twice as reliable as the valuation based on a revenue multiple?

Answer: Relative valuation methods assume that the peer firms selected to compute the valuation multiple are substantially similar to
the target firm at a moment in time. These multiples in turn reflect investor assumptions about continued user growth and the ability
of Twitter to convert increased user growth into profitable advertising revenue. Assume that the analyst reasons that the enterprise to
EBITDA multiple is a far more reliable measure of firm value than estimates based on a multiple of revenue because it relates firm
value directly to a measure of cash flow rather than simply revenue which may not be profitable. The analyst can then calculate a
weighted average of the two estimates, with the weight associated with estimate of firm value based on the revenue multiple set at
one-third and the other estimate’s weight set at two-thirds. That is, ($12.33 x .333 + $25.35 x .666) = $4.11 + 16.88 billion = $20.99.

4. Scenario analysis involves valuing businesses based on different sets assumptions about the future. What are the advantages and
disadvantages of applying this methodology in determining an appropriate purchase price using relative valuation methods to
estimate firm value?

Answer: Scenario analysis enables the analyst to create several different scenarios such as most likely, least likely and optimistic and
to weight each by the probability that each will occur. In doing so, the analyst is implicitly adjusting for risk or the probability of
different outcomes. Consequently, an important advantage of this approach is that it requires the analyst to make subjective estimates
about risk. The primary disadvantage is that this method requires far more assumptions than other methodologies.

China’s CNOOC Acquires Canadian Oil and Gas Producer Nexen Inc.
______________________________________________________________

20
Key Points
 DCF valuation assumes implicitly that management has little decision-making flexibility once an investment decision is made.
 In practice, management may accelerate, delay, or abandon the original investment as new information is obtained.
_____________________________________________________________________________

In its largest foreign takeover ever, China’s state owned energy company CNOOC acquired Canadian oil and gas company Nexen Inc. in
2013 for $15.1 billion. The acquisition gives CNOOC new offshore production in the North Sea, the Gulf of Mexico, offshore of western
Africa, and oil and gas properties in the Middle East and Canada. The deal also gives CNOOC control of major oil sands reserves in
Canada.

This acquisition by CNOOC represents an effort to secure geographically distributed sources of existing production and future reserves
as well as a bet on the future development of nonconventional oil and gas reserves such as the Canadian oil sands. Given the nature of the
reserves, their development is considerably more costly than conventional crude reserves. Also, the process by which oil sands are
converted to usable crude oil releases more carbon into the atmosphere than conventional crude extraction. This has created substantial
opposition among environmental groups seeking to limit or eliminate further development of oil sands. Consequently, there is a real
question as to the long-term value of such reserves.

The pace at which these new oil sands reserves would be developed by CNOOC would depend on the future demand for oil and global
oil prices and the ability to overcome objections to their development. Opposition to further development of the reserves had also blocked
construction of the pipelines necessary to transport the oil to energy hungry consumers in the U.S. and to Canada’s west coast to enable
export to China. Continued opposition to further development of these properties could reduce their value significantly. Given these
uncertainties what options does CNOOC have with respect to these reserves?

Standard discounted cash flow analysis assumes implicitly that once CNOOC made this investment decision to buy Nexen, CNOOC’s
management could do little to alter the investment stream it had included in the calculation of future cash flows used to value Nexen. In
reality, management has a series of so-called real options enabling changes to be made to their original investment decisions. Which
option would be pursued was contingent on certain future developments. These options include the decision to expand (i.e., accelerate
investment), delay investment, or abandon an investment.

With respect to CNOOC’s acquisition of Nexen, the major uncertainties deal with the actual timing and amount of the projected cash
flows. In practice, CNOOC’s management could accelerate investment in the Canadian oil sands reserves if oil prices were to rise
sufficiently (and were likely to remain at those levels) to offset the higher development costs and if environmental opposition could be
overcome, enabling the construction of additional pipeline capacity. In the absence of lessening hostility from environmentalists,
investment to develop the reserves could be delayed until circumstances improved. If concerns about the release of carbon precluded
further development of reserves beyond current oil sands drilling and extraction operations, CNNOC could abandon the reserves and spin-
off or divest already developed oil sands fields. While expensive, the latter option allows the firm to limit future losses. The bottom line
is that management has considerably greater decision-making flexibility than is implicit in traditional discounted cash flow analysis.

Is Texas Instruments Overpaying for National Semiconductor? As Always, It depends.

Key Points
Valuation is far more an art than a science, and understanding the limitations of individual valuation methods is critical.
Averaging multiple valuation methods is often the most reliable means of valuing a firm.
Evaluating success of an individual acquisition is best viewed in the context of an acquirer’s overall business strategy.

Value is in the eye of the beholder. Various indicators often provide a wide range of estimates. No single method seems to provide
consistently accurate valuation estimates. Which method the analyst ultimately selects often depends on the availability of data and on the
analyst’s own biases. Whether a specific acquisition should be viewed as successful depends on the extent to which it helps the acquirer
realize a successful business strategy.
At $25 per share in cash, Texas Instruments (TI) announced on March 5, 2011, that it had reached an agreement to acquire National
Semiconductor (NS). The resulting 78% premium over NS’s closing share price the day prior to the announcement raised eyebrows. After
showing little activity in the days immediately prior to the announcement, NS’s share price soared by 71% and TI’s share price rose by
2.25% immediately following the announcement. While it is normal for the target’s share price to rise sharply to reflect the magnitude of

21
the premium, the acquirer’s share price sometimes remains unchanged or even declines. The increase in TI’s share price seems to suggest
agreement among investors that the acquisition made sense. However, within days, analysts began to ask the question that bedevils so
many takeovers. Did Texas Instruments overpay for National Semiconductor?

Whether TI overpaid depends on how you measure value and how you interpret the results. Looking at recent semiconductor industry
transactions, the magnitude of the premium is almost twice the average paid on 196 acquisitions in the semiconductor industry during the
last several years. Based on price-to-earnings ratio analysis, TI paid 19.1 times NS’s 2012 estimated earnings, as compared to 14.3 times
industry average earnings for the same year. This implied that TI was willing to pay $19.10 per share for each dollar of the next year’s
earnings per NS share. In contrast, investors were generally willing to pay on average on $14.30 for each dollar of 2012 earnings for the
average firm in the semiconductor industry. Using a ratio of market capitalization (market price) to sales, it also appears that TI’s
premium is excessive. TI paid four times NS’s current annual sales, well above other key competitors. such as Maxim Integrated Products
and Intersil, which traded at 3.2 and 1.8 times sales, respectively.

The enterprise-value-to-sales ratio compares the value of a firm to its revenue and gives investors an idea of how much it costs to buy
the company’s sales. Some analysts believe that it is a more useful indicator than a market-capitalization-to-sales ratio, which considers
only how equity investors value each dollar of sales, since the market-cap-to-sales ratio ignores that the firm’s current debt must be
repaid. By this measure, TI is willing to pay $4.40 for each dollar of revenue, as compared to $3.80 per dollar of sales for the average
semiconductor firm. Another useful valuation ratio, the price-to-earnings ratio divided by the earnings growth rate (PEG ratio), also
suggested that TI might have overpaid. The PEG ratio relates what investors are willing to pay for a firm per dollar of earnings to the
growth rate of earnings. At 1.28 prior to the TI takeover, NS was trading at a premium to its growth rate according to this measure. After
the acquisition, the PEG ratio jumped to 2.09.

While suggesting strongly that TI overpaid, these measures may be seriously biased. A large percentage of TI’s and NS’s revenue
comes from the production and sale of analog chips, a rapidly growing segment of the semiconductor industry. Part of the growth in
analog chips is expected to come from the explosive growth of smartphones and tablets, where their use in regulating electricity
consumption is crucial to longer battery life. Consequently, many of the previous acquisitions in the semiconductor industry are of firms
that do not compete in the analog chip market; as such, they are not entirely comparable. Moreover, many of these acquisitions came
amidst a sluggish economic recovery and were made at “fire-sale” prices.

With the exception of comparisons with recent comparable transactions, all of these valuation measures do not consider directly the
value of synergy. There was little overlap between TI’s and NS’s product offering. TI believes that they can increase substantially NS’s
sales by selling their products through TI’s much larger sales force. Furthermore, TI added 12,000 new analog chip products, bringing its
combined offering to more than 30,000 products. TI also gets access to a number of analog engineers, who are highly specialized and
relatively rare. Finally, in the highly fragmented semiconductor industry, consolidation among competitors may lead to higher average
selling prices than would have been realized otherwise.

The acquisition of NS by TI should be viewed in the context of a longer-term strategy in which TI is seeking an ever-increasing share
of the $42 billion analog chip market, which many analysts expect to outgrow the overall semiconductor market during the next three to
five years. Following the financial crisis in 2008, TI acquired analog chip manufacturing facilities at “fire-sale” prices to boost the firm’s
capacity. The NS acquisition will give TI a 17% share of this rapidly growing market segment.

Discussion Questions

1. Most studies purporting to measure the success or failure of acquisitions base their findings of the performance of acquiring
share prices around the announcement date of the acquisition or on accounting performance measures during the three to
five years following the acquisition. This requires that acquisitions be evaluated on a “standalone” basis. Do you agree or
disagree with this methodology? Explain your answer.

Answer: While event studies have merit to the extent markets are efficient, they often fail to recognize that acquisitions
usually are undertaken as part of a larger strategy. If the acquisition enables the implementation of the larger strategy and
that strategy makes sense, then the success of the acquisition should be considered in the context of the larger strategy. This
is analogous to interdependent investment projections. Evaluations of acquisitions subsequent to the announcement suffer
from the probability that other factors such as the business cycle will mask the actual performance of the acquired firm.

Whether TI paid too much should be evaluated in the context of its longer term strategy to capture an increasing share of the
analog chip market which is expected to be among the fastest growing segments of the total computer chip market. The

22
 acquisition of National Semiconductor reflects the largest in a series of similar acquisitions made by the firm since 2008 in
an effort to implement its longer term strategy of increasing its share of the analog chip market.

2. Despite their limitations, why is the judicious application of the various valuation methods critical to the acquirer in
determining an appropriate purchase price?

Answer: Individual valuation methods routinely provide significantly different valuations because they are estimated using
substantially different approaches, with some incorporating both the risk and timing of future cash flows (i.e., DCF) and
others reflecting investor sentiment at a moment in time (i.e., relative valuation). Nevertheless, depending on the availability
of data, multiple methods should be employed and then averaged to provide a reality check to limit the tendency for the
acquiring firm to overstate the value of anticipated synergy, perhaps due to excessive optimism or hubris.

The differences in valuation estimates are certainly evident with Texas Instruments’ acquisition of National Semiconductor.
For example, TI paid twice the average premium on a recent transactions basis and about one-third more on a comparable
companies’ basis. However, neither of these approaches may accurately reflect the value of synergy between the two firms
that may be considerably greater than for comparable transactions. The potential for incremental cross selling revenues is
believed to be great due to the limited overlap between the two firms’ customer sets; the dramatic expansion in the
combined firms’ product offering also provides opportunities to generate additional revenue by packaging or bundling
product sales. Finally, the acquisition gives TI access to a large number of relatively scarce analog chip engineers, which
could give the combined firms a competitive edge in their effort acquire a leading position in the analog chip business.

3. Scenario analysis involves valuing businesses based of different sets assumptions about the future. What are the advantages
and disadvantages of applying this methodology in determining an appropriate purchase price?

Answer: Scenario analyses require a range of estimates based on alternative sets of assumptions. The offer price is then
based on the expected value of the estimates associated with the scenarios. This methodology is prone to generate a more
conservative estimate because it includes a range of estimates around what the firm believes is the most likely outcome and
may preclude the buyer from making a preemptive bid. The overarching advantage of scenario analysis is that it requires to
acquirer to consider alternative outcomes and the implications of the assumptions underlying each scenario.

4. Do you agree or disagree with the following statement: Valuation is more an art than a science. Explain your answer.

Answer: The scientific method requires that repetition of the same experiment will result in an identical outcome. It is clear
from the variation of estimates derived from the various methods reflecting different time periods and data limitations that
accuracy of a valuation depends more on the analyst’s understanding of what determines valuation in each situation than on
the valuation methodology. In this sense, it is clearly far more an art than a science.

Valuation estimation should begin with a thorough understanding of the industry in which the target firm competes, how
cash flow is generated by firms in the industry, and how the target’s core capabilities compare to key competitions. With this
background, the analyst is able to determine which valuation methods are most appropriate for a specific situation, subject to
the availability of data. Whether TI paid too much ultimately reflects the plausibility of assumptions underlying their
anticipated synergy with National Semiconductor and the ability of the two firms to realize these synergies on a timely basis.

Bristol-Myers Squibb Places a Big Bet on Inhibitex

___________________________________________________________
Key Points
DCF valuation assumes implicitly that management has little decision-making flexibility once an investment decision is made.
In practice, management may accelerate, delay, or abandon the original investment as new information is obtained.
______________________________________________________________________________________________________________

Pharmaceutical firms in the United States are facing major revenue declines during the next several years because of patent expirations for
many drugs that account for a substantial portion of their annual revenue. The loss of patent protection will enable generic drug makers to
sell similar drugs at much lower prices, thereby depressing selling prices for such drugs across the industry. In response, major

23
pharmaceutical firms are inclined to buy smaller drug development companies whose research and developments efforts show promise in
order to offset the expected decline in their future revenues as some “blockbuster” drugs lose patent protection.

Aware that its top-selling blood thinner, Plavix, would lose patent protection in May 2012, Bristol-Myers Squibb (Bristol-Myers)
moved aggressively to shed its infant formula and other noncore businesses to focus on pharmaceuticals. Such restructuring has reduced
employment from 40,000 in 2008 to 26,000 in 2011. Bristol-Myers’ strategy has been either to acquire firms with promising drugs under
development or to develop them internally. However, the firm faced an uphill struggle to offset the potential loss of $6.7 billion in annual
Plavix revenue, which represented about one-third of the firm’s total annual revenue.

In early January 2012, Bristol-Myers announced that it had reached an agreement to purchase hepatitis C drug developer Inhibitex Inc.
for $2.5 billion. Inhibitex focuses on treatments for bacterial and viral infections. It had annual revenue of only $1.9 million and an
operating loss of $22.7 million in 2011. The lofty purchase price reflected Bristol-Myers’ growth expectations for the firm’s hepatitis C
treatment INX-189, based on very early phase one clinical testing trials, with larger trials scheduled for 2013. The all-cash deal for $26
per share represented a 164% premium to Inhibitex’s closing price on January 10, 2012.

Bristol-Myers valued Inhibitex in terms of the expected cash flows resulting from the commercialization of hepatitis C treatment INX-
189. Standard discounted cash flow analysis assumes implicitly that once Bristol-Myers makes an investment decision, it cannot change
its mind. In reality, management has a series of so-called real options enabling them to make changes to their original investment decision
contingent on certain future developments.

These options include the decision to expand (i.e., accelerate investment at a later date), delay the initial investment, or abandon an
investment. With respect to Bristol-Myers’ acquisition of Inhibitex, the major uncertainties deal with the actual timing and amount of the
projected cash flows. In practice, Bristol-Myers’ management could expand or accelerate investment in the new Inhibitex drug, contingent
on the results of subsequent trials. The firm could also delay additional investment until more promising results are obtained. Finally, if
the test results suggest that the firm is not likely to realize the originally anticipated developments, it could abandon or exit the business
by spinning-off or divesting Inhibitex or by shutting it down. The bottom line is that management has considerably greater decision-
making flexibility than is implicit in traditional discounted cash flow analysis.

Google Buys YouTube: Valuing a Firm Without Cash Flows

YouTube ranks as one of the most heavily utilized sites on the Internet, with one billion views per day, 20 hours of new video uploaded
every minute, and 300 million users worldwide. Despite the explosion in usage, Google continues to struggle to “monetize” the traffic on
the site five years after having acquired the video sharing business. 2010 marked the first time the business turned marginally profitable.
Whether the transaction is viewed as successful depends on whether it is evaluated on a stand-alone basis or as part of a larger strategy
designed to steer additional traffic to Google sites and promote the brand.

This case study illustrates how a value driver approach to valuation could have been used by Google to estimate the potential value of
YouTube by collecting publicly available data for a comparable business. Note the importance of clearly identifying key assumptions
underlying the valuation. The credibility of the valuation ultimately depends on the credibility of the assumptions.

Google acquired YouTube in late 2006 for $1.65 billion in stock. At that time, the business had been in existence only for 14 months,
consisted of 65 employees, and had no significant revenues. However, what it lacked in size it made up in global recognition and a rapidly
escalating number of site visitors. Under pressure to continue to fuel its own meteoric 77 percent annual revenue growth rate, Google
moved aggressively to acquire YouTube in an attempt to assume center stage in the rapidly growing online video market. With no debt,
$9 billion in cash, and a net profit margin of about 25 percent, Google was in remarkable financial health for a firm growing so rapidly.
The acquisition was by far the most expensive acquisition by Google in its relatively short eight-year history. In 2005, Google spent
$130.5 million in acquiring 15 small firms. Google seemed to be placing a big bet that YouTube would become a huge marketing hub as
its increasing number of viewers attracts advertisers interested in moving from television to the Internet.

Started in February 2005 in the garage of one of the founders, YouTube displayed in 2006 more than 100 million videos daily and had
an estimated 72 million visitors from around the world each month, of which 34 million were unique. 1 As part of Google, YouTube

1 Unique visitors are those whose IP addresses are counted only once no matter how many times they visit a website during a given period.

24
retained its name and current headquarters in San Bruno, California. In addition to receiving funding from Google, YouTube was able to
tap into Google's substantial technological and advertising expertise.

To determine if Google would be likely to earn its cost of equity on its investment in YouTube, we have to establish a base-year free
cash-flow estimate for YouTube. This may be done by examining the performance of a similar but more mature website, such as
about.com. Acquired by The New York Times in February 2005 for $410 million, about.com is a website offering consumer information
and advice and is believed to be one of the biggest and most profitable websites on the Internet, with estimated 2006 revenues of almost
$100 million. With a monthly average number of unique visitors worldwide of 42.6 million, about.com's revenue per unique visitor was
estimated to be about $0.15, based on monthly revenues of $6.4 million.2

By assuming these numbers could be duplicated by YouTube within the first full year of ownership by Google, YouTube could
potentially achieve monthly revenue of $5.1 million (i.e., $0.15 per unique visitor × 34 million unique YouTube visitors) by the end of
year. Assuming net profit margins comparable to Google's 25 percent, YouTube could generate about $1.28 million in after-tax profits on
those sales. If that monthly level of sales and profits could be sustained for the full year, YouTube could achieve annual sales in the
second year of $61.2 million (i.e., $5.1 × 12) and profit of $15.4 million ($1.28 × 12). Assuming optimistically that capital spending and
depreciation grow at the same rate and that the annual change in working capital is minimal, YouTube's free cash flow would equal after-
tax profits.

Recall that a firm earns its cost of equity on an investment whenever the net present value of the investment is zero. Assuming a risk-
free rate of return of 5.5 percent, a beta of 0.82 (per Yahoo! Finance), and an equity premium of 5.5 percent, Google's cost of equity
would be 10 percent. For Google to earn its cost of equity on its investment in YouTube, YouTube would have to generate future cash
flows whose present value would be at least $1.65 billion (i.e., equal to its purchase price). To achieve this result, YouTube's free cash
flow to equity would have to grow at a compound annual average growth rate of 225 percent for the next 15 years, and then 5 percent per
year thereafter. Note that the present value of the cash flows during the initial 15-year period would be $605 million and the present value
of the terminal period cash flows would be $1,005 million. Using a higher revenue per unique visitor assumption would result in a slower
required annual growth rate in cash flows to earn the 10 percent cost of equity. However, a higher discount rate might be appropriate to
reflect YouTube's higher investment risk. Using a higher discount rate would require revenue growth to be even faster to achieve an NPV
equal to zero.

Google could easily have paid cash, assuming that the YouTube owners would prefer cash to Google stock. Perhaps Google saw its
stock as overvalued and decided to use it now to minimize the number of new shares that it would have had to issue to acquire YouTube,
or perhaps YouTube shareholders simply viewed Google stock as more attractive than cash.

With YouTube having achieved marginal profitability in 2010, it would appear that the valuation assumptions implicit in Google's
initial valuation of YouTube may, indeed, have been highly optimistic. While YouTube continues to be wildly successful in terms of the
number of site visits, with unique monthly visits having increased almost six fold from their 2006 level, it appears to be disappointing at
this juncture in terms of profitability and cash flow. The traffic continues to grow as a result of integration with social networks such as
Facebook and initiatives such as the ability to send clips to friends as well as to rate and comment on videos. Moreover, YouTube is
showing some progress in improving profitability by continuing to expand its index of professionally produced premium content.
Nevertheless, on a stand-alone basis, it is problematic that YouTube will earn Google’s cost of equity. However, as part of a broader
Google strategy involving multiple acquisitions to attract additional traffic to Google and to promote the brand, the purchase may indeed
make sense.
.
Discussion Questions:

1. What alternative valuation methods could Google have used to justify the purchase price it paid for YouTube? Discuss the
advantages and disadvantages of each.

Answer: Alternative methods include comparable recent transactions (e.g., News Corp’s purchase of MySpace in 2005),
comparable recent transactions, and discounted cash flow. Advantages of using the recent comparable transactions method is
that it shows what investors are actually willing to pay for a similar company; however, this method is limited by the paucity of
truly recent transactions. Moreover, this valuation method may be distorted depending on when the transaction took place in the
business cycle. Similarly, the comparable companies’ method is limited by the availability of comparable firms. Moreover, it
needs to be adjusted for a purchase price premium. Care must be taken not to “over-adjust” if the price of comparable
2 Aboutmediakit, September 17, 2006, http://beanadvertiser.about.com/archive/news091606.html
.

25
 companies has already been inflated by expectations of future acquisitions of these types of firms. Finally, neither recent
transactions’ or comparable transactions’ methods adjust for the timing of when cash flows are received and the risk associated
with future cash flows. While DCF methods adjust for the risk of future cash flows and the timing of such cash flows, the
calculation requires numerous assumptions whose accuracy may be problematic.

2. The purchase price paid for YouTube represented more than one percent of Google’s then market value. If you were a Google
shareholder, how might you have evaluated the wisdom of the acquisition?

Answer: Shareholders could view this acquisition as an opportunity to get more unique visitors to Google or as representing
potentially significant dilution to future earnings.

3. To what extent might the use of stock by Google have influenced the amount they were willing to pay for YouTube? How might
the use of “overvalued” shares impact future appreciation of Google stock?

Answer: Google’s P/E was trading at 77 times last twelve months and 46 times next twelve months’ earnings at the time of the
transaction. Stock may have been used if management viewed it as overvalued and hence not likely to dilute future earnings.

4. What is the appropriate cost of equity for discounting future cash flows? Should it be Google’s or YouTube’s? Explain your
answer.

Answer: The appropriate cost of equity should be YouTube’s since it represents the marginal risk that Google is assuming by
acquiring YouTube. YouTube’s cost of equity should include an adjustment for firm size due to its small size and high
associated specific business risk.

5. What are the key valuation assumptions implicit in the valuation method discussed in this case study?

Answer: The cost of equity is assumed to be 10% and cash flow is assumed to grow at 225% per annum for 15 years and then
5% thereafter.

A REAL OPTIONS' PERSPECTIVE ON MICROSOFT'S DEALINGS WITH YAHOO

In a bold move to transform two relatively weak online search businesses into a competitor capable of challenging market leader Google,
Microsoft proposed to buy Yahoo for $44.6 billion on February 2, 2008. At $31 per share in cash and stock, the offer represented a 62
percent premium over Yahoo's prior day closing price. Despite boosting its bid to $33 per share to offset a decline in the value of
Microsoft's share price following the initial offer, Microsoft was rebuffed by Yahoo's board and management. In early May, Microsoft
withdrew its bid to buy the entire firm and substituted an offer to acquire the search business only. Incensed at Yahoo's refusal to accept
the Microsoft bid, activist shareholder Carl Icahn initiated an unsuccessful proxy fight to replace the Yahoo board. Throughout this entire
melodrama, critics continued to ask how Microsoft could justify an offer valued at $44.6 billion when the market prior to the
announcement had valued Yahoo at only $27.5 billion.

Microsoft could have continued to slug it out with Yahoo and Google, as it has been for the last five years, but this would have given
Google more time to consolidate its leadership position. Despite having spent billions of dollars on Microsoft's online service (Microsoft
Network or MSN) in recent years, the business remains a money loser (with losses exceeding one half billion dollars in 2007).
Furthermore, MSN accounted for only 5 percent of the firm's total revenue at that time.

Microsoft argued that its share of the online Internet search (i.e., ads appearing with search results) and display (i.e., website banner
ads) advertising markets would be dramatically increased by combining Yahoo with MSN. Yahoo also is the leading consumer email
service. Anticipated cost savings from combining the two businesses were expected to reach $1 billion annually. Longer term, Microsoft
expected to bundle search and advertising capabilities into the Windows operating system to increase the usage of the combined firms'
online services by offering compatible new products and enhanced search capabilities.

The two firms have very different cultures. The iconic Silicon Valley–based Yahoo often is characterized as a company with a free-
wheeling, fun-loving culture, potentially incompatible with Microsoft's more structured and disciplined environment. Melding or
eliminating overlapping businesses represents a potentially mind-numbing effort given the diversity and complexity of the numerous sites

26
available. To achieve the projected cost savings, Microsoft would have to choose which of the businesses and technologies would survive.
Moreover, the software driving all of these sites and services is largely incompatible.

As an independent or stand-alone business, the market valued Yahoo at approximately $17 billion less than Microsoft's valuation.
Microsoft was valuing Yahoo based on its intrinsic stand-alone value plus perceived synergy resulting from combining Yahoo and MSN.
Standard discounted cash flow analysis assumes implicitly that, once Microsoft makes an investment decision, it cannot change its mind.
In reality, once an investment decision is made, management often has a number of opportunities to make future decisions based on the
outcome of things that are currently uncertain. These opportunities, or real options, include the decision to expand (i.e., accelerate
investment at a later date), delay the initial investment, or abandon an investment. With respect to Microsoft's effort to acquire Yahoo, the
major uncertainties dealt with the actual timing of an acquisition and whether the two businesses could be integrated successfully. For
Microsoft's attempted takeover of Yahoo, such options included the following:

Base case. Buy 100 percent of Yahoo immediately.

Option to expand. If Yahoo were to accept the bid, accelerate investment in new products and services contingent on the successful
integration of Yahoo and MSN.
Option to delay. (1) Temporarily walk away keeping open the possibility of returning for 100 percent of Yahoo if circumstances
change, (2) offer to buy only the search business with the intent of purchasing the remainder of Yahoo at a later date, or (3) enter into a
search partnership, with an option to buy at a later date.
Option to abandon. If Yahoo were to accept the bid, spin off or divest combined Yahoo/MSN if integration is unsuccessful.

The decision tree in the following exhibit illustrates the range of real options (albeit an incomplete list) available to the Microsoft
board at that time. Each branch of the tree represents a specific option. The decision-tree framework is helpful in depicting the significant
flexibility senior management often has in changing an existing investment decision at some point in the future.

With neither party making headway against Google, Microsoft again approached Yahoo in mid-2009, which resulted in an
announcement in early 2010 of an internet search agreement between the two firms. Yahoo transferred control of its internet search
technology to Microsoft in an attempt to boost its sagging profits. Microsoft is relying on a 10-year arrangement with Yahoo to help
counter the dominance of Google in the internet search market. Both firms hope to be able to attract more advertising dollars paid by
firms willing to pay for links on the firms’ sites.

Option to expand
contingent on
successful
integration of
Yahoo and MSN

Purchase Yahoo
online search only.
Buy remaining
businesses later.

Base Case:
Microsoft offers Option to postpone Enter long-term
to buy all contingent on search partnership
outstanding Yahoo’s rejection with option to buy.
share of Yahoo of offer

27
 Offer revised price
for all of Yahoo if
circumstances
change

Spin off combined

Yahoo and MSN to
Microsoft
Option to abandon
shareholders
contingent on
failure to integrate
Yahoo and MSN
Divest combined
Yahoo and MSN.
Use proceeds to
Microsoft Real Options Decision Tree pay dividend or
buy back stock.

Merrill Lynch and BlackRock Agree to Swap Assets

During the 1990s, many financial services companies began offering mutual funds to their current customers who were pouring money
into the then booming stock market. Hoping to become financial supermarkets offering an array of financial services to their customers,
these firms offered mutual funds under their own brand name. The proliferation of mutual funds made it more difficult to be noticed by
potential customers and required the firms to boost substantially advertising expenditures at a time when increased competition was
reducing mutual fund management fees. In addition, potential customers were concerned that brokers would promote their own firm's
mutual funds to boost profits.

This trend reversed in recent years, as banks, brokerage houses, and insurance companies are exiting the mutual fund management
business. Merrill Lynch agreed on February 15, 2006, to swap its mutual funds business for an approximate 49 percent stake in money-
manager BlackRock Inc. The mutual fund or retail accounts represented a new customer group for BlackRock, founded in 1987, which
had previously managed primarily institutional accounts.

At $453 billion in 2005, BlackRock's assets under management had grown four times faster than Merrill's $544 billion mutual fund
assets. During 2005, BlackRock's net income increased to $270 million, or 63 percent over the prior year, as compared to Merrill's 27
percent growth in net income in its mutual fund business to $397 million. BlackRock and Merrill stock traded at 30 and 19 times
estimated 2006 earnings, respectively.

Merrill assets and net income represented 55 percent and 60 percent of the combined BlackRock and Merrill assets and net income,
respectively. Under the terms of the transaction, BlackRock would issue 65 million new common shares to Merrill. Based on BlackRock's
February 14, 2005, closing price, the deal is valued at $9.8 billion. The common stock gave Merrill 49 percent of the outstanding
BlackRock voting stock. PNC Financial and employees and public shareholders owned 34 percent and 17 percent, respectively. Merrill's
ability to influence board decisions is limited, since it has only 2 of 17 seats on the BlackRock board of directors. Certain "significant
matters" require a 70 percent vote of all board members and 100 percent of the nine independent members, which include the two Merrill
representatives. Merrill (along with PNC) must also vote its shares as recommended by the BlackRock board.

Discussion Questions:

1. Merrill owns less than half of the combined firms, although it contributed more than one- half of the combined firms’ assets and
net income. Discuss how you might use DCF and relative valuation methods to determine Merrill’s proportionate ownership in
the combined firms.

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 a. Answer using DCF methods:

PV(Merrill) = $397/(.10 - .04) = $6,617

PV(BlackRock) = $270/(.10 - .06) = $6,750
PV (Combined Firms) = $13,367
PV(Merrill)/PV(Comb Firms) = 49.5%

b. Answer using relative valuation methods:

PV(Merrill) = 397 x 19 = $7,543

PV(BlackRock) = 270 x 30 = $8,100
PV(Combined Firms) =$15,643
PV(Merrill/PV(Comb. Firms) = 48.2%

2. Why do you believe Merrill was willing to limit its influence in the combined firms?

Answer: Increased competition in the retail mutual fund business would result in eroding margins and perceived conflicts of
interests with Merrill brokers promoting Merrill funds would slow overall sales growth. BlackRock may be considered a neutral
party, as it does not use brokers. Consequently, BlackRock’s long-term growth potential may be higher than Merrill’s.

3. What method of accounting would Merrill use to show its investment in BlackRock?

Answer: The equity method of accounting in which Merrill displays its 49% investment in BlackRock valued at $9.8 billion as
an asset on its balance sheet. BlackRock’s balance sheet displays 100% of the combined Merrill and BlackRock assets
valued at $20 billion (i.e., $9.8 billion / .49) on its balance sheet with an offsetting liability item called minority investments in
BlackRock equal to $9.8 billion.

Valuation Methods Employed in Investment Bank Fairness Opinion Letters

Background

A fairness opinion letter is a written third-party certification of the appropriateness of the price of a proposed transaction such as a merger,
acquisition, leveraged buyout, or tender offer. A typical fairness opinion provides a range of what is believed to be fair values, with a
presumption that the actual deal price should fall within this range. The data used in this case study is found in SunGard’s Schedule 14A
Proxy Statement submitted to the SEC in May 2005.

On March 27, 2005, the investment banking behemoth Lazard Freres (Lazard) submitted a letter to the board of directors of SunGard
Corporation pertaining to the fairness of a $10.9 billion bid to take the firm private made by an investor group. Lazard employed a variety
of valuation methods to evaluate the offer price. These included the comparable company approach, the recent transactions method,
discounted cash flow analysis, and an analysis of recent transaction premiums. The analyses were applied to each of the firm’s major
businesses: software services and recovery availability services. The software services’ business provides software systems and support
for application and transaction processing to financial services firms, universities, and government agencies. The recovery availability
services business provides businesses and government agencies with backup and recovery support in the event their data processing
systems are disrupted.

Comparable Company Analysis

Using publicly available information, Lazard reviewed the market values and trading multiples of the selected publicly held companies
for each business segment. Multiples were based on stock prices as of March 24, 2005 and specific company financial data on publicly
available research analysts’ estimates for 2005. In the case of SunGard’s software business, Lazard reviewed the market values and
trading multiples of four publicly traded financial services companies and three publicly traded securities trading companies. In the case
of SunGard’s recovery availability services business, Lazard reviewed the market values and trading multiples of the six selected publicly

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traded business continuity services (i.e., recoverability services firms) companies. These firms were believed to be representative of these
segments of SunGard’s operations.

Lazard calculated enterprise values for these comparable companies as equity value plus debt, preferred stock, and all out-of-the-
money convertibles (i.e., convertible debt whose conversion price exceeded the merger offer price), less cash and cash equivalents (i.e.,
short-term liquid securities). Estimated enterprise value multiples of earnings before interest, taxes, depreciation and amortization (i.e.,
EBITDA) were created for 2005 by dividing enterprise values by publicly available estimates of EBITDA for each comparable company.
Similarly, price-to-earnings ratios were created by dividing equity values per share by earnings per share for each comparable company
for calendar 2005. See Tables 8-1 and 8.2.

Table 8-1 Enterprise Value Multiples for

Comparable Recovery Availability Companies
Enterprise Value as a Multiple of Price-to-Earnings
EBITDA Multiple (P/E)
2005E 2005E
High 9.0x 38.1x
Mean 6.7x 18.2x
Median 6.5x 15.3x
Low 3.8x 12.6x
E = estimate.

Based on this analysis, Lazard determined an enterprise value to estimated 2005 EBITDA multiple range for SunGard’s recovery
availability services business of 5.5x to 7.0x. Lazard also determined a 2005 estimated P/E range for this segment of 14.0x to 16.0x.
Multiplying SunGard’s projected EBITDA and earnings per share for 2005 by these ranges, Lazard calculated an enterprise value range
for SunGard’s recovery availability services business of approximately $3.1 billion to $3.7 billion. Financial projections for SunGard
were provided by SunGard’s management.

Table 8-2. Enterprise Value Multiples for Comparable Software Companies

Enterprise Value as a Multiple of Price-to-Earnings
EBITDA Multiple (P/E)
High 13.8x 21.5x
Mean 9.7x 18.8x
Median 9.0x 18.1x
Low 7.3x 16.9x

Based on the results in Table 8-2, Lazard determined an enterprise value to estimated 2005 EBITDA multiple range for SunGard’s
software business of 7.5x to 9.5x. Lazard also determined a 2005 estimated P/E range for SunGard’s software business of 17.0 to 19.0x.
Multiplying SunGard’s projected EBITDA and earnings per share for 2005 by these ranges, Lazard calculated an enterprise value range
for SunGard’s software business of approximately $4.3 billion to $5.2 billion.

Lazard then summed the enterprise value ranges for SunGard’s software business and recovery availability services business to
calculate a consolidated enterprise value range for SunGard of approximately $7.4 billion to $8.9 billion. Using this consolidated
enterprise value range and assuming net debt (i.e., total debt less cash and cash equivalents on the balance sheet) of $273 million, Lazard
calculated an implied price per share range for SunGard common stock of $24.20 to $29.00 by dividing the enterprise value less net debt
by the SunGard shares outstanding.

Recent Transactions Method

For the recovery availability services business, Lazard reviewed ten merger and acquisition transactions since October 2001 for
companies in the information technology outsourcing business. To the extent publicly available, Lazard reviewed the transaction
enterprise values of the recent transactions as a multiple of the last twelve months EBITDA for the period ending on the recent transaction
announcement date. See Table 8-3.

Table 8-3. Enterprise Value as a Multiple of Last Twelve Months EBITDA

for Recovery Availability Business

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High 10.8x
Mean 7.37x
Median 6.4x
Low 5.4x

Based on Table 8-3, Lazard determined an EBITDA multiple range of 6.5x to 7.5x and multiplied this range by the last twelve months
EBITDA for SunGard’s recovery availability business to calculate an implied enterprise value range of approximately $3.4 billion to $4.0
billion.

Lazard reviewed 21 merger and acquisition transactions since February 2003 with a value greater than approximately $100 million for
companies in the software business. To the extent publicly available, Lazard examined the transaction enterprise values of the recent
transactions as a multiple of EBITDA for the last twelve months prior to the public announcement of the relevant recent transaction. See
Table 8-4.

Table 8-4. Enterprise Value as a Multiple of Last Twelve Months EBITDA

for the Software Business
High 11.6x
Mean 9.8x
Median 9.9x
Low 6.8x

Based on the information contained in Table 8-5, Lazard determined an EBITDA multiple range of 9.0x to 11.0x and multiplied this
range by the last twelve month EBITDA for SunGard’s software business to calculate an implied enterprise value range for this business
segment of approximately $5.0 billion to $6.1 billion.

Lazard then summed the enterprise value ranges for SunGard’s software business and recovery availability services business to
calculate a consolidated enterprise value range for SunGard of approximately $8.4 billion to $10.1 billion. Using this consolidated
enterprise value range and assuming net debt of $273 million, Lazard calculated the value per share of SunGard common stock of $27.60
to $32.70 by dividing the estimated consolidated enterprise value less net debt by common shares outstanding.

Discounted Cash Flow Analysis

Using projections provided by SunGard’s management, Lazard performed an analysis of the present value, as of March 31, 2005, of the
free cash flows that SunGard could generate annually from calendar year 2005 through calendar year 2009. Lazard analyzed separately
the cash flows for SunGard’s software business and recovery availability services business.

For SunGard’s software business, in calculating the terminal value, Lazard assumed perpetual growth rates (i.e., constant growth
model) of 3.5% to 4.5% for the projected free cash flows for the periods subsequent to 2009. The projected annual cash flows through
2009 and beyond were then discounted to present value using discount rates ranging from 10.0% to 12.0%. Based on this analysis, Lazard
calculated an implied enterprise value range for the software business of approximately $5.6 billion to $7.4 billion.

For SunGard’s recovery availability services business, in calculating the terminal value Lazard assumed perpetual growth rates of
2.0% to 3.0% for the projected free cash flows for periods subsequent to 2009. The projected cash flows were then discounted to present
value using discount rates ranging from 10.0% to 12.0%. Lazard then calculated an implied enterprise value range for SunGard’s recovery
availability business of approximately $2.6 billion to $3.3 billion.

Lazard then aggregated the enterprise value ranges for SunGard’s two business segments to calculate a consolidated enterprise value
range for SunGard of approximately $8.2 billion to $10.7 billion. Using this consolidated enterprise value range and assuming net debt of
$273 million, Lazard calculated an implied price per share range for SunGard common stock of $26.70 to $34.60.

Premiums Paid Analysis

Lazard performed a premiums paid analysis based upon the premiums paid in 73 recent transactions (not involving “mergers of equals”
transactions) that were announced from January 2004 through March 2005 and involved transaction values in excess of $1 billion. In

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conducting its analysis, Lazard analyzed the premiums paid for recent transactions over $1 billion and those over $5 billion, since
premiums paid may vary with the size of the transaction.

The analysis was based on the one day, one week and four week implied premiums for the transactions examined. The implied
premiums were calculated by comparing the offer price for the target firm on the announcement date with the per share price of the target
firm one day, one week, and four weeks prior to the announcement of the transaction. The results of these calculations are given in Table
8-5.

Table 8-5. Premiums Paid Analysis

Greater Than $1 Billion1 Greater Than $5 Billion
1 Day 1 Week 1 Month 1 Day 1 Week 1 Month
High 69.8% 67.8% 80.2% 33.4% 38.3% 44.0%
Mean 23.8% 26.6% 27.0% 15.3% 23.1% 26.2%
Median 21.3% 24.0% 25.7% 13.0% 25.4% 23.7%
Low (9.5)%2 (8.0)% (19.6)% 0.0% (1.2)% 5.4%
1
The larger premiums paid for smaller transaction may reflect their potentially higher growth potential .
2
Negative premiums may be a result of target firms whose expected financial performance had been
deteriorating during the month prior to the announcement date.

Based on this analysis, Lazard determined an applicable premium range of 20% to 30% for SunGard and applied this range to
SunGard’s share price of $24.95 on March 18, 2005. Using this information, Lazard calculated an implied price per share range for
SunGard common stock of $29.94 (i.e., 1.2 x $24.95) to $32.44 (1.3 x $24.95).

Summary and Conclusions

Table 8-6 summarizes the estimated valuation ranges based on the alternative valuation methods employed by Lazard Freres. Note that
the $36 per offer price compares favorably to the estimated average valuation range, representing a premium of 12% (i.e., $36/$27.11) to
33% (i.e., $36/$32.19). Consequently, Lazard Freres viewed the investor group’s offer price for SunGard as fair.

Table 8-6. Valuation Range Summary

Valuation Method Valuation Range ($/Common (Max. Valuation less Min.
Share) Valuation)/Min. Valuation
Comparable Companies 24.20-29.00 19.8%
Recent Transactions 27.60-32.70 18.5%
Discounted Cash Flow 26.70-34.60 29.6%
Premiums Paid 29.94-32.44 8.4%
Average 27.11-32.19 18.7%

Discussion Questions:

1. Discuss the strengths and weaknesses of each valuation method employed by these investment banks in constructing estimates of
SunGard’s value for the Fairness Opinion Letter. Be specific.

Answer:

a. Discounted cash flow: Strengths include consideration of differences of the magnitude and timing of cash flows, the
adjustment for risk, and a clear statement of valuation assumptions. Weaknesses include the requirement to forecast
cash flows for each period, a terminal value, and a discount rate using limited or unreliable data. DCF methods are also
highly sensitive to the accuracy of cash flow and discount rate estimates. Finally, the terminal value may constitute a
disproportionately large share of the total value.
b. Comparable companies: Advantages include utilizing market-based P/E, sales, or book value for similar companies.
Disadvantages include the difficulty in finding comparable firms, reliance on accounting-based historical information,
and potential distortion because of current market psychology.

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 c. Recent transactions: The primary advantage is that it represents the price a willing buyer and seller were willing to pay
at that moment in time. Disadvantages include the lack of comparable recent transactions and the limited availability of
recent transaction data.
d. Premiums paid: Advantages include actual premiums paid for recent transactions. Disadvantages include the potential
distortion of premiums due to current market psychology. Moreover, premiums paid may also be inflated if other firms
in the same industry have been recently acquired.

2. Why do you believe that the percentage difference between the maximum and minimum valuation estimates varies so much from
one valuation method to another? See Table 8-7.

Answer: Each method the comparable companies, recent transactions, and premiums paid methods rely on the accuracy of the
samples selected. Are the companies selected truly representative? EBITDA and earnings per share projections are based on
analyst’s publicly available forecasts. Studies show that such projections are often excessively optimistic. The DCF method
relies on financial projections based on the target’s management and may be overly optimistic. Assuming the recent transactions
are truly comparable, they are likely to be the most accurate, because they represent transaction prices between willing
buyers and sellers at that point in time.

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