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Corporate Finance

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Corporate Finance ­FIN 622
VU
Lesson 35
SHARE VALUATIONS
We shall take up following topics in this hand out:
Assets Based Share Valuations
Hybrid Valuation methods
Procedure for public takeover
Procedure for private takeover
Anti-takeover tools
o  Poison pill
o  Pac man
o  White knight
o  Counter offer
o  Disposal of key assets
o  Acquisition by the target
o  Shark repellent
o  Political pressure
Assets Based Share Valuations
Asset-based methods typically involve restating both assets and liabilities to their current values to arrive at
a net asset value. The restatement can be done on an individual component level (discrete valuation) or
collectively (collective valuation). Given the relative difficulty of individually valuing a variety of assets, such
as real estate, machinery and equipment, and inventory, it is often necessary to employ valuation specialists.
Collective valuation requires a single analysis, which identifies the collective value of the assets and liabilities
over and above their recorded value (i.e., a price-to-book multiple). Even with asset-based models, value
remains a function of expected benefits to the owners. The value of assets is generally derived from either
future income-generating potential or liquidation value, depending on the circumstances at a given time.
Some add a fourth approach to valuation to the three that we describe in this handout. They argue that you
can argue the individual assets owned by a firm and use that to estimate its value ­ asset based valuation
models. In fact, there are several variants on asset based valuation models. The first is liquidation value,
which is obtained by aggregating the estimated sale proceeds of the assets owned by a firm. The second is
replacement cost, where you evaluate what it would cost you to replace all of the assets that a firm has
today.
While analysts may use asset-based valuation approaches to estimate value, we do not consider them
alternatives to discounted cash flow, relative or option pricing models since both replacement and
liquidation values have to be obtained using one or more of these approaches. Ultimately, all valuation
models attempt to value assets ­ the differences arise in how we identify the assets and how we attach value
to each asset. In liquidation valuation, we look only at assets in place and estimate their value based upon
what similar assets are priced at in the market. In traditional discounted cash flow valuation, we consider all
assets including expected growth potential to arrive at value.
The two approaches may, in fact, yield the same values if you have a firm that has no growth assets and the
market assessments of value reflect expected cash flows.
Asset based methods are generally considered suitable when shareholdings > 50% are being valued. Such
shareholdings give the holder the right to control the acquisition and disposal of the underlying assets.
Therefore, if there are assets not needed for generation of income, the controlling shareholders may cause
these to be realized to generate cash.
Book Values: these figures are bases on past or historical costs and are meaningless and useless to be used
for merger transaction valuations.
Replacement Cost: this should provide a measure of the maximum amount that any buyer should pay for
the whole business, since it represents the total cost of forming the business from scratch. However, a
major element of any business as a going concern is likely to be the goodwill. Since this can only be defined
as income based value of business ­ tangible assets it may be seen that there is no real way of applying a
pure asset based value to a business. It is always necessary to consider an income-based value as well.
Break up value: is the assets in the business will often be less than any other computed value. It represents
the minimum price, which should be accepted for the sale of a business as a going concern, since if the
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Corporate Finance ­FIN 622
VU
income based valuations give figures lower than the break up value it is apparent that the owner would be
better off by ceasing to trade and selling off all the assets piecemeal.
However, when a break up is considered in this way it must be remembered to include such items as
redundancy costs, liquidator's which may have substantial effect on the final outcome.
Hybrid Methods ­ Mix Of Asset Based & Income Method:
The income and asset-based approaches to valuation have relative strengths as well as obvious limitations.
For example, the income approach allows for specific and direct estimation of future benefits to the owners,
which is consistent with the theory of value. On the other hand, if the estimation of future benefits is
directly based on historical income, the precision of the estimate will depend heavily on the persistence
embodied in the historical income measure and on the growth assumptions incorporated into the model. If,
for example, current or historical income contains large transitory components, the relationship between
historical and future income may be distorted. In addition, to the extent an inappropriate discount rate is
utilized, value estimates will be adversely affected.
Asset-based valuation approaches can be effective in that the accurate identification of individual asset and
liability values will yield a reliable value estimate. In addition, unlike the income approach, an equity
discount rate, the estimation of which can have a significant impact on the valuation conclusion, is not
required for an asset-based approach. On the other hand, it is often difficult to accurately restate book value
to current value for an array of assets, especially when a significant amount of unrecorded intangible assets
exists.
This method includes the characteristics of both income and asset based valuation methods. For example,
the income approach allows for specific and direct estimation of future benefits to the owners, which is
consistent with the theory of value.
The estimation of future benefits is directly based on historical income; the precision of the estimate will
depend heavily on the persistence embodied in the historical income measure and on the growth
assumptions incorporated into the model asset-based valuation approaches can be effective in that the
accurate identification of individual asset and liability values will yield a reliable value estimate. in addition,
unlike the income approach, an equity discount rate, the estimation of which can have a significant impact
on the valuation conclusion, is not required for an asset-based approach.
Taken collectively, however, income and asset-based valuations generally yield better valuation accuracy and
more-effective analysis, which is the real benefit of a hybrid approach.
Acquisition Procedures:
·
Procedure for public take over:
·
Growth / expansion is decided
·
Predator company appoints experts ­ legal consultants, banks, accountants and stock brokers
·
Decision regarding contact with target firm ­ approach before the bid or hostile takeover
·
Purchase of certain % age of shares of target
·
Establish an offer and communicate target
Includes offer document, offer validity, predator may revise offer if declined by target
·
Acquisition of private company:
·
Limited consultancy services from expert are required. internal evaluation is normally enough.
·
Detailed investigation is conducted before the transaction.
·
Offer price is negotiated by both parties
·
Finalization of deal by entering into a contract
·
Payment of price finishes the deal.
Anti-takeover tools:
Takeovers are not easy ­ there is always some opposition to takeovers by some or all of the stakeholders of
target company. In this section, you will learn how to thwart a takeover attempt successfully. The following
methods have been used in practical life to stop a takeover:
Poison pill:
Poison pill originally meant a literal poison pill (often a glass vial of cyanide salts) carried by various spies
throughout history, and by Nazi leaders in WWII Spies could take such pills when discovered, eliminating
any possibility that they could be interrogated for the enemy's gain. It has since become a term referring to
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Corporate Finance ­FIN 622
VU
any strategy, generally in business or politics, to increase the likelihood of negative results over positive ones
for anyone who attempts any kind of takeover.
Pac-Man:
The Pac-Man defense is a defensive option to stave off a hostile takeover. It is when a company that is
under a hostile takeover acquires its would-be buyer.
The most quoted example in U.S. corporate history is the attempted hostile takeover of Martin Marietta by
Bendix Corporation in 1982. In response, Martin Marietta started buying Bendix stock with the aim of
assuming control over the company. Bendix persuaded Allied Corporation to act as a "white knight," and
the company was sold to Allied the same year. The incident was labeled a "Pac-Man defense" in retrospect.
The name refers to when Pac-Man, the star of the videogame of the same name, turns around and devours
the ghost that was previously pursuing him (after eating a Power Pill that allows him to do so). The term
(though not the technique) was coined by buyout guru Bruce Wasserstein.
White knight (business)
In business, a white knight may be a corporation, a private company, or a person that intends to help
another firm. There are many types of white knights.
The first type refers to the friendly acquirer of a target firm in a hostile takeover attempt by another firm.
The intention of the acquisition is to circumvent the takeover of the object of interest by a third, unfriendly
entity, which is perceived to be less favorable. The knight might defeat the undesirable entity by offering a
higher and more enticing bid, or strike a favorable deal with the management of the object of acquisition.
In short, if Company T (target) is going to be acquired by Company H (hostile firm), but Company A
(acquirer) can acquire ownership of Company T, and then Company A would be acting as the white knight.
The second type refers to the acquirer of a struggling firm that may not necessarily be under threat by a
hostile firm. The financial standing of the struggling firm could prevent any other entity being interested in
an acquisition. The firm may already have huge debts to pay to its creditors, or worse, may already be
bankrupt. In such a case, the knight, under huge risk, acquires the firm that is in crisis. After acquisition, the
knight then rebuilds the firm, or integrates it into itself
Disposal of Key Assets:
Disposal of key assets is also very important tools which go in anti, because some times vital assets when go
to liquidate or companies go to amalgamate then, too many hurdles come in order to process the disclosure
of the assets, because investment made by the investor.
Acquisition by the Target:
A targeted repurchase is a technique used to thwart a hostile takeover in which the target firm purchases
back its own stock from an unfriendly bidder, usually at a price well above market value.
Politics
Political pressure is an effective anti-take over tool. Two good examples will make you understand better
how a government can stop takeover bid.
DWP ­ Middle East based port company acquired the management of some US ports after successful
bidding. Later, as the congress raised concern about the security of its ports, US president had to interfere
to stop this bid. On the same lines, an Indian business tycoon had a successful bidding of a French steel
manufacturer but later French government intervened and cancelled the bid.
A poison pill may also be used in politics such as attaching an amendment so distasteful to a bill that even
the bill's supporters are forced to vote against it. This manipulative tactic may be intended to simply kill the
bill, or to create a no-win situation for the bill's supporters, so that the bill's opponents can accuse them of
voting for something bad no matter what. This is sometimes known as a "wrecking amendment".
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Table of Contents:
  1. INTRODUCTION TO SUBJECT
  2. COMPARISON OF FINANCIAL STATEMENTS
  3. TIME VALUE OF MONEY
  4. Discounted Cash Flow, Effective Annual Interest Bond Valuation - introduction
  5. Features of Bond, Coupon Interest, Face value, Coupon rate, Duration or maturity date
  6. TERM STRUCTURE OF INTEREST RATES
  7. COMMON STOCK VALUATION
  8. Capital Budgeting Definition and Process
  9. METHODS OF PROJECT EVALUATIONS, Net present value, Weighted Average Cost of Capital
  10. METHODS OF PROJECT EVALUATIONS 2
  11. METHODS OF PROJECT EVALUATIONS 3
  12. ADVANCE EVALUATION METHODS: Sensitivity analysis, Profitability analysis, Break even accounting, Break even - economic
  13. Economic Break Even, Operating Leverage, Capital Rationing, Hard & Soft Rationing, Single & Multi Period Rationing
  14. Single period, Multi-period capital rationing, Linear programming
  15. Risk and Uncertainty, Measuring risk, Variability of return–Historical Return, Variance of return, Standard Deviation
  16. Portfolio and Diversification, Portfolio and Variance, Risk–Systematic & Unsystematic, Beta – Measure of systematic risk, Aggressive & defensive stocks
  17. Security Market Line, Capital Asset Pricing Model – CAPM Calculating Over, Under valued stocks
  18. Cost of Capital & Capital Structure, Components of Capital, Cost of Equity, Estimating g or growth rate, Dividend growth model, Cost of Debt, Bonds, Cost of Preferred Stocks
  19. Venture Capital, Cost of Debt & Bond, Weighted average cost of debt, Tax and cost of debt, Cost of Loans & Leases, Overall cost of capital – WACC, WACC & Capital Budgeting
  20. When to use WACC, Pure Play, Capital Structure and Financial Leverage
  21. Home made leverage, Modigliani & Miller Model, How WACC remains constant, Business & Financial Risk, M & M model with taxes
  22. Problems associated with high gearing, Bankruptcy costs, Optimal capital structure, Dividend policy
  23. Dividend and value of firm, Dividend relevance, Residual dividend policy, Financial planning process and control
  24. Budgeting process, Purpose, functions of budgets, Cash budgets–Preparation & interpretation
  25. Cash flow statement Direct method Indirect method, Working capital management, Cash and operating cycle
  26. Working capital management, Risk, Profitability and Liquidity - Working capital policies, Conservative, Aggressive, Moderate
  27. Classification of working capital, Current Assets Financing – Hedging approach, Short term Vs long term financing
  28. Overtrading – Indications & remedies, Cash management, Motives for Cash holding, Cash flow problems and remedies, Investing surplus cash
  29. Miller-Orr Model of cash management, Inventory management, Inventory costs, Economic order quantity, Reorder level, Discounts and EOQ
  30. Inventory cost – Stock out cost, Economic Order Point, Just in time (JIT), Debtors Management, Credit Control Policy
  31. Cash discounts, Cost of discount, Shortening average collection period, Credit instrument, Analyzing credit policy, Revenue effect, Cost effect, Cost of debt o Probability of default
  32. Effects of discounts–Not effecting volume, Extension of credit, Factoring, Management of creditors, Mergers & Acquisitions
  33. Synergies, Types of mergers, Why mergers fail, Merger process, Acquisition consideration
  34. Acquisition Consideration, Valuation of shares
  35. Assets Based Share Valuations, Hybrid Valuation methods, Procedure for public, private takeover
  36. Corporate Restructuring, Divestment, Purpose of divestment, Buyouts, Types of buyouts, Financial distress
  37. Sources of financial distress, Effects of financial distress, Reorganization
  38. Currency Risks, Transaction exposure, Translation exposure, Economic exposure
  39. Future payment situation – hedging, Currency futures – features, CF – future payment in FCY
  40. CF–future receipt in FCY, Forward contract vs. currency futures, Interest rate risk, Hedging against interest rate, Forward rate agreements, Decision rule
  41. Interest rate future, Prices in futures, Hedging–short term interest rate (STIR), Scenario–Borrowing in ST and risk of rising interest, Scenario–deposit and risk of lowering interest rates on deposits, Options and Swaps, Features of opti
  42. FOREIGN EXCHANGE MARKET’S OPTIONS
  43. Calculating financial benefit–Interest rate Option, Interest rate caps and floor, Swaps, Interest rate swaps, Currency swaps
  44. Exchange rate determination, Purchasing power parity theory, PPP model, International fisher effect, Exchange rate system, Fixed, Floating
  45. FOREIGN INVESTMENT: Motives, International operations, Export, Branch, Subsidiary, Joint venture, Licensing agreements, Political risk