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Module 9

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15 views12 pages

Module 9

Uploaded by

sidwiz350
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Module 9: Loose Ends in Valuation

• Cash, Cross Holdings, and Other Assets


Non-Operating Assets
1. Cash and near-cash investments—investments in riskless or very
low-risk investments
2. investments in equities and bonds of other firms,
3. The third is holdings in other firms, private and public,
4. Assets that do not generate cash flows but nevertheless could have
value
• In late 2023, S&P 500 companies had enough cash to give almost $8,000 to

every person in the United States. That included large technology

companies like Apple, Alphabet. and Microsoft. Apple alone reported

having more than $166 billion in cash and investments on its balance sheet.

To put this number into perspective, that is more than the annual GDP of

Ukraine, a country with a population of almost 40 million people.


CASH AND NEAR-CASH INVESTMENTS

• Why Do Companies Hold Cash?


• Operating (Transactions)
• Cash-oriented versus credit-oriented businesses.
• Small versus large transactions.
• Banking system.
Precautionary Motives
• Volatility in the economy.
• Volatility in operations.
• Competitive environment.
• Financial leverage.
• Future Capital
• Magnitude of and uncertainty about future investments.
• Access to capital markets.
• Information asymmetry about investments.
Strategic Cash Holdings
Management Interests
• Corporate governance.
• Insider holdings
Categorizing Cash Holdings
• Operating versus Nonoperating (Excess)
• Rule of thumb.
• Industry average.
• Cross-sectional regressions.
Wasting versus Nonwasting
• CyberTech Inc. had an average cash balance of $200 million in the
2004 financial year and it reported interest income of $4.2 million
from these holdings. If the average Treasury bill rate during the period
was 2.25 percent, what is the wasting cash component.
Dealing with Cash Holdings in Valuation
• Valuing Cash in a Discounted Cash Flow Valuation
• Consolidated Valuation
• The net income will then include income from investments in government securities, corporate bonds, and
equity investments
• You have to adjust the inputs to the valuation model—cash flows, growth rates, and discount rates—to maintain
consistency.

• Consider a firm with investments of $1,200 million in noncash operating assets and $200 million in cash.
For simplicity, let us assume the following.
• The noncash operating assets have a beta of 1 and are expected to earn $120 million in net income each
year in perpetuity, and there are no reinvestment needs (to match the assumption of no growth).
• The cash is invested at the riskless rate, which we assume to be 4.5%.
• The net income is returned to stockholders every year (as dividends or buybacks).
• The market risk premium is assumed to be 5.5%.
• The firm is all equity funded.
Value of Synergy
• What is synergy?
• Operating Synergy
• Economies of scale
• Greater pricing power (sometimes its oligopoly)
• Combination of different functional strengths
• Higher growth in new or existing markets
• Financial Synergy
• Due to Higher cash flows or lower cost of capital
• A combination of a firm with excess cash, and a firm
with high-return projects (small firm by large and
private by public firm)
• Debt capacity can increase (due to stability)
• Tax benefits
• Diversification
VALUING SYNERGY
• Valuing Operating Synergies ?????
• Will it reduce costs as a percentage of sales and increase profit margins (e.g.,
when there are economies of scale)?
• Will it increase future growth (e.g., when there is increased market power)
• Steps in Valuing Operating Synergy
• Value the firms involved in the merger independently
• Estimate the value of the combined firm with no synergy
• Build the effects of synergy into expected growth rates and cash flows
• Revalue the combined firm
Valuing Operating Synergy in a DCF
Framework
• Cost synergies Metric
Acquiring
Firm
Target
Firm
• Growth synergies Beta 0.9 0.9
Pretax Cost of Debt 5% 5%
• The combined firm may be Tax Rate 30% 30%
able to earn higher returns Debt-to-Capital Ratio 10% 10%
on its investments Revenues $1,000 $500
• The combined firm may be Operating Income (EBIT) $50 $25
able to find more
investments Pretax Return on Capital 15% 15%
• The combined firm may be Reinvestment Rate 70% 70%
Example: The in
risk-free
a much ratemore
is 4.25%, and the risk premium is
powerful
4%. For purposes of simplicity, we will assume that both Length of Growth Period 5 years 5 years
competitive position
firms will be in stable growth after year 5, growing 4.25% a
year in perpetuity and earning no excess returns
To value synergy, assume that the combined firm will save $15
million in pretax operating expenses

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