Index
A
account forecasting alternatives, 82
accounting dilemmas. See also financial reporting
assessing economic reality, 183-184
asset capitalization policy
overview, 196
R&D (research and development) costs, 197
balance sheets
asset capitalization policy, 196-199
asset revaluation policy, 199-200
off-balance-sheet debt, 200-205
CFFO (cash flow from operating activities), 205-206
income statements, 185
inventory costing policy, 190-193
recurring and nonrecurring events, 185-186
revenue recognition policy, 186-189
acquisition accounting, 214-218
acquisitions. See M&As (mergers and acquisitions)
adjusted present value model. See APV (adjusted present value) model
Almunia, Joaquín, 229
alternative valuation methods, 135
case study: Pure Digital, 133-134
DCF (discounted cash flow) models
APV (adjusted present value) model, 145-155
versus economic income models, 164-165
economic income models
price multiples
enterprise value multiples, 141-144
price-to-cash flow ratio, 139-140
Amoco, 5
APV (adjusted present value) model
overview, 145
Argentina, nationalization of YPF, 85-86
Article 12.5 of the TRLIS, 211
assessing economic reality, 183-184
asset capitalization policy, 196
asset revaluation policy, 199-200
assets
asset capitalization policy, 196
asset revaluation policy, 199-200
asset turnover, decomposition analysis of, 34-38
noncurrent assets ratios, 36
B
balance sheets
asset capitalization policy, 196-199
off-balance-sheet debt, 200-205
contingent liabilities, 202-203
Bank One, 2
best practices for valuation, 108-109
borrowing base, 221
BP (British Petroleum), 5
break-up value, 11
British Airways, 195
British Petroleum (BP), 5
C
calculating. See also equations
acquirer’s hurdle rate, 100-101
CAPM (capital asset pricing model), 152
continuing value
perpetuity growth method, 103-104
cost of unleveraged equity, 146
FCF to equity, 156
ITS (interest tax shield), 145
capital asset pricing model (CAPM), 146, 152
CAPM (capital asset pricing model), 146, 152
cash flow. See also DCF (discounted cash flow) models
CFFF (cash flow from financing activities), 44-46
CFFI (cash flow from investing activities), 44
CFFO (cash flow from operating activities), 44
CFFF (cash flow from financing activities), 42, 44-46, 205-206
CFFI (cash flow from investing activities), 42, 44, 205-206
CFFO (cash flow from operating activities), 42, 44, 205-206
for DCF (discounted cash flow) models, 93-96
discretionary cash flow, 43
cash flow from financing activities (CFFF), 42, 44-46, 205-206
cash flow from investing activities (CFFI), 42, 44, 205-206
cash flow from operating activities (CFFO), 42, 44, 187, 205-206
cash flow statement, 69
CFC (controlled foreign corporation) rule, 222
CFFF (cash flow from financing activities), 42, 44-46, 205-206
CFFI (cash flow from investing activities), 42, 44, 205-206
CFFO (cash flow from operating activities), 42, 44, 187, 205-206
choosing valuation methods, 230-233
Cisco Systems, 133-134, 137-138
CNA Financial Corporation, 206
consolidated financial statements
accounting for goodwill, 220-221
full consolidation approach, 218-220
tax considerations
of goodwill, 224
of M&As (mergers and acquisitions), 222-223
contingent liabilities, 202-203
perpetuity growth method, 103-104
controlled foreign corporation (CFC) rule, 222
cost method (financial reporting), 213-214
cost of unleveraged equity, 146
cross-border considerations, 109-212
D
DCF (discounted cash flow) models
acquirer’s hurdle rate, 100-101
APV (adjusted present value) model
overview, 145
versus economic income models, 164-165
debt
contingent liabilities, 202-203
decomposition analysis, 32
integrative framework, 41
Deutsche Telekom (DT), 211-212
direct valuation methods, 17, 135
DCF (discounted cash flow) models
acquirer’s hurdle rate, 100-101
APV (adjusted present value) model, 145-155
versus economic income models, 164-165
economic income models
discount rate for DCF (discounted cash flow) models, 96-97
discounted cash flow models. See DCF (discounted cash flow) models
discretionary cash flow
overview, 43
dividend discount model, 129
DoubleClick, 23
drivers of option value, 167-168
DT (Deutsche Telekom), 211-212
E
earnings multiples, 15-16, 87-91
advantages, 91
limitations, 91
earnings per share (EPS), 15
EBO (Edwards-Bell-Ohlson) model, 159
economic reality, assessing, 183-184
economic value added (EVA) model, 159. See also economic income models
Edwards-Bell-Ohlson (EBO) model, 159
Electronic Data System, 1
enterprise value multiples, 16, 141-144
entity value
calculating, 146
EPS (earnings per share), 15
CAPM (capital asset pricing model), 152
continuing value, 104
cost of unleveraged equity, 146
equity value, 106
FCF to equity, 156
ITS (interest tax shield), 145
operating value, 93
WACC (weighted average cost of capital), 97-100
equity method (financial reporting), 214
equity risk premium (ERP), 98
cost of unleveraged equity, 146
EVA (economic value added) model, 159. See also economic income models
EV/EBITDA multiple, 16, 141-144
events, recurring versus nonrecurring, 185-186
expropriation risk, 109
F
FASB (Financial Accounting Standards Board), 190
FCF (free cash flow), 93-96, 205-206
for DCF (discounted cash flow) models, 93-96
acquirer’s hurdle rate, 100-101
cross-border considerations, 109-111
FCF to the firm model
acquirer’s hurdle rate, 100-101
cross-border considerations, 109-111
frequently asked questions, 124
FIFO (first in, first out), 183, 190-192
Financial Accounting Standards Board (FASB), 190
financial leverage, decomposition analysis of, 38-41
asset capitalization policy
overview, 196
R&D (research and development) costs, 197
balance sheets
asset capitalization policy, 196-199
asset revaluation policy, 199-200
off-balance-sheet debt, 200-205
CFFO (cash flow from operating activities), 205-206
consolidated financial statements
accounting for goodwill, 220-221
full consolidation approach, 218-220
economic reality, assessing, 183-184
income statements, 185
inventory costing policy, 190-193
recurring and nonrecurring events, 185-186
revenue recognition policy, 186-189
of goodwill, 224
of M&As (mergers and acquisitions), 222-223
case study: Microsoft acquisition of aQuantive, 23-24
decomposition analysis, 32
integrative framework, 41
integrative framework, 41
asset capitalization policy
overview, 196
R&D (research and development) costs, 197
balance sheets
asset capitalization policy, 196-199
asset revaluation policy, 199-200
off-balance-sheet debt, 200-205
CFFO (cash flow from operating activities), 205-206
consolidated financial statements
accounting for goodwill, 220-221
full consolidation approach, 218-220
income statements, 185
inventory costing policy, 190-193
recurring and nonrecurring events, 185-186
revenue recognition policy, 186-189
for pro forma analysis
tax considerations
of goodwill, 224
of M&As (mergers and acquisitions), 222-223
financial synergies, 7
first in, first out (FIFO), 190-192
Fitch, report on Mattel, 48
Ford, 6
forecasting
CFFO (cash flow from operating activities), 205-206
forecasting period (DCF model), 92-93
forward multiples, 88
free cash flow. See FCF (free cash flow)
full consolidation approach, 218-220
fundamental value, 11
G
GAAP (generally accepted accounting principles), 213
General Electric Company, 4
General Motors Acceptance Corporation (GMAC), 201
generally accepted accounting principles (GAAP), 213
GlaxoSmithKline, 5
GMAC (General Motors Acceptance Corporation), 201
goodwill, 215
tax considerations, 224
H
Hewlett-Packard (HP), 1
historical financial review. See financial review
HP (Hewlett-Packard), 1
I
ICSID (International Centre for Settlement of Investment Disputes), 86
IFRS (International Financial Reporting Standards), 185
impairment, 199
Imperial Sugar Company, inventory costing policy, 190-193
implied price, 89
income statements, 185
inventory costing policy, 190-193
recurring and nonrecurring events, 185-186
revenue recognition policy, 186-189
interest tax shield (ITS), 145
International Centre for Settlement of Investment Disputes (ICSID), 86
International Financial Reporting Standards (IFRS), 185
International Harvester Corporation, 3-4
inventory costing policy, 183-184, 190-193
ITS (interest tax shield), 145
J-K-L
Krichner, Cristina Fernández de, 85-86
last in, first out (LIFO), 190-192
LBOs (leveraged buyouts), 5
leveraged beta, 146
leveraged buyouts (LBOs), 5
liabilities, contingent, 202-203
LIFO (last in, first out), 190-192
liquidation value, 11
liquidity ratios, 39
Loews Corporation, 206
Luehrman, 178
Lufthansa, 195
M
M&As (mergers and acquisitions)
creation of shareholder value, 8-9, 232
cross-border M&A activity, 212
mergers and acquisitions “waves,” 3-6
value destruction, 10
managerial synergies, 7
market value, 11
Mattel
common-size income statement data, 33
discretionary cash flow, 46-47
earnings multiples analysis, 89-91
economic income models, 162-163
FCF to the firm model, 111-118
financial statements, 66
Fitch report, 48
pro forma analysis
pro forma financial statements, 53-57
ROE (return on shareholders’ equity) model, 31-32
working capital and noncurrent ratios, 37-38
McDonald’s, 36
mergers and acquisitions. See M&As (mergers and acquisitions)
methods of valuation. See valuation methods
models
DCF (discounted cash flow) models
acquirer’s hurdle rate, 100-101
FCF to the firm model
acquirer’s hurdle rate, 100-101
cross-border considerations, 109-111
nondiscounted cash flow models, 18-19
Monsanto, 5
Monte Carlo simulation analysis, 59
Moody’s Analytics, 26
Morningstar, 26
motivations for M&As (mergers and acquisitions), 6-8
multiples
definition of, 14
advantages, 91
limitations, 91
forward multiples, 88
price multiples
earnings multiples. See earnings multiples
enterprise value multiples, 16, 141-144
price-to-book (P/Book) ratio, 140-141
price-to-cash flow ratio, 139-140
trailing multiples, 88
N
negative spread, 160
net operating profit after taxes (NOPAT), 159
net profit margins, decomposition analysis of, 32-34
Nextel Communications, 1
nondiscounted cash flow models, 18-19
noncontrolling interest, 218-220
noncurrent assets ratios, 36
nonrecurring events in income statements, 185-186
Nortel Networks Corporation, 188-189
NPV/q, 178
O
off-balance-sheet debt, 200-205
contingent liabilities, 202-203
operating value, 93
operational dilemmas (DCF)
acquirer’s hurdle rate, 100-101
perpetuity growth method, 103-104
option value, real option analysis, 165-170
overconfidence, 24
P
P/Book (price-to-book) ratio, 15, 140-141
P/CF (price-to-cash flow), 139-140
P/E (price-to-earnings) ratio, 15, 87-88, 89-91
P/EBIT (price-to-earnings before interest and taxes) ratio, 15, 87-88
P/EBITDA (price-to-earnings before interest, taxes, depreciation, and amortization) ratio, 15, 87-88, 141-144
permanent earnings, 185
perpetuity growth method, 103-104
phantom profit, 193
Pharmacia, 5
policies
asset capitalization policy, 196
asset revaluation policy, 199-200
inventory costing policy, 190-193
revenue recognition policy, 186-189
positive spread, 160
premiums, M&As (mergers and acquisitions) premiums, 9-10
preparation of pro forma financial statements, 49-53
price multiples
advantages, 91
limitations, 91
enterprise value multiples, 16, 141-144
price-to-cash flow ratio, 139-140
price-to-book (P/Book) ratio, 15, 140-141
price-to-cash flow ratio, 139-140
price-to-earnings (P/E) ratio, 15, 87-88, 89-91
price-to-earnings before interest and taxes (P/EBIT) ratio, 15, 87-88
price-to-earnings before interest, taxes, depreciation, and amortization (P/EBITDA) ratio, 15, 87-88
pro forma analysis, 49
case study: Microsoft acquisition of aQuantive, 23-24
financial statements
Monte Carlo simulation analysis, 60
scenario analysis, 60
Providence Equity Partners, 143
P/Sales (price-to-sales) ratio, 136-139
Pure Digital, 133-134, 137-138
Q-R
Quaker Oats, 1
R&D (research and development) costs, 197
ratio analysis, 26-27. See also ratios
integrative framework, 41
ratios. See also ratio analysis; value
liquidity ratios, 39
noncurrent assets ratios, 36
price-to-book (P/Book) ratio, 15, 140-141
price-to-cash flow ratio, 139-140
price-to-earnings (P/E) ratio, 15, 87-91
price-to-earnings before interest and taxes (P/EBIT) ratio, 15, 87-88
price-to-earnings before interest, taxes, depreciation, and amortization (P/EBITDA) ratio, 15, 87-88
rear-end loading, 196
recurring events in income statements, 185-186
relative valuation methods, 14, 135
advantages, 91
limitations, 91
enterprise value multiples, 16
price multiples
earnings multiples. See earnings multiples
enterprise value multiples, 141-144
price-to-book (P/Book) ratio, 140-141
price-to-cash flow ratio, 139-140
asset capitalization policy
overview, 196
R&D (research and development) costs, 197
balance sheets
asset capitalization policy, 196-199
asset revaluation policy, 199-200
off-balance-sheet debt, 200-205
CFFO (cash flow from operating activities), 205-206
consolidated financial statements
accounting for goodwill, 220-221
full consolidation approach, 218-220
economic reality, assessing, 183-184
income statements, 185
inventory costing policy, 190-193
recurring and nonrecurring events, 185-186
revenue recognition policy, 186-189
tax considerations
of goodwill, 224
of M&As (mergers and acquisitions), 222-223
return on shareholders’ equity (ROE) model, 29-32, 41
revenue recognition policy, 186-189
Revenue Reconciliation Act of 1993, 224
ROE (return on shareholders’ equity) model, 29-32, 41
S
scenario analysis, 60
Securities and Exchange Commission (SEC), 138
shareholder value, impact of M&As (mergers and acquisitions) on, 8-9, 232
shareholder’s equity, return on, 29-32, 41
Snapple, 1
solvency ratios, 39
spread, 160
Sprint, 1
Squibb Corporation, 181. See also Bristol-Myers Squibb
Standard & Poor’s, 26
statements. See financial statements
Stern Stewart & Company, 159
subsidiaries
consolidated financial statements
accounting for goodwill, 220-221
full consolidation approach, 218-220
tax considerations
of goodwill, 224
of M&As (mergers and acquisitions), 222-223
synergies
financial synergies, 7
managerial synergies, 7
T
tangible net worth, 221
tax considerations
of M&As (mergers and acquisitions), 222-223
tax havens, 222
Thomson Reuters, 26
T-Mobile, 211
traditional valuation methods
cross-border considerations, 109-111
DCF (discounted cash flow) models
acquirer’s hurdle rate, 100-101
overview, 92
advantages, 91
limitations, 91
trailing multiples, 88
transparency regimes, 222
trend analysis, 26
turnover, asset turnover, 34-38
U
undiversifiable risk, 98
United Parcel Service (UPS), 229-230
United States Steel Corporation, 3-4
unleveraged beta, 146
UPS (United Parcel Service), 229-230
V
valuation methods, 134
case studies
cross-border considerations, 109-111
DCF (discounted cash flow) models
acquirer’s hurdle rate, 100-101
APV (adjusted present value) model, 145-155
versus economic income models, 164-165
advantages, 91
limitations, 91
economic income models
nondiscounted cash flow models, 18-19
price multiples
earnings multiples. See earnings multiples
enterprise value multiples, 16, 141-144
price-to-book (P/Book) ratio, 140-141
price-to-cash flow ratio, 139-140
relative valuation methods, 14
value. See also ratios
break-up value, 11
perpetuity growth method, 103-104
calculating, 146
fundamental value, 11
liquidation value, 11
market value, 11
operating value, 93
option value, real option analysis, 165-170
shareholder value, impact of M&As (mergers and acquisitions) on, 8-9, 232
value destruction in M&As (mergers and acquisitions), 10
Value Line, 26
Volvo, 6
W-X-Y-Z
WACC (weighted average cost of capital), 97-100
“waves” of M&As (mergers and acquisitions), 3-6
weighted average cost method, 190