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Good day Sir,
Please see the below paragraph extracted from the lecture notes as it relates to the Free CF Method. I don’t understand the paragraph especially the part about enlarged company. Would you be able to explain it in other words please?
“All of the above ignore the fact that there may well be synergy benefits from the acquisition of the other company and that as a result the total free cash flow may be higher than the sum of the current cash flows in the individual companies.
In this situation, instead of valuing separately the company being acquired, we should value the new ‘enlarged’ company (using the free cash flows of the ‘enlarged’ company) and subtract the current value of the acquiring company to arrive at an estimate of the amount worth paying for the acquisition.”Suppose Company A currently has a value of 10M and is considering acquiring Company B which currently has a value of 5M. Obviously they are going to have to pay at least 5M for Company B.
However if they do acquire B then because of synergistic benefits they expect that the value of A will increase to 17M after the acquisition. Since this is 7M more than the current value of A, it means that they would be prepared to pay up to 7M for Company B (although obviously they will want to offer less).
So they will expect to have to pay somewhere between 5M and 7M. The actual amount paid will determine how much of the benefit ends up going to shareholders of A and how much ends up going to the existing shareholders of B.
Have you not watched the free lectures that go with the lecture notes? The notes are only lecture notes and should not be used on their own – it is in the lectures that I explain and expand on the notes.
Thank you sir!
I did view the notes but was a little unsure about this one.
Thanks 🙂
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