• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer
Finance Train

Finance Train

High Quality tutorials for finance, risk, data science

  • Home
  • Data Science
  • CFA® Exam
  • PRM Exam
  • Tutorials
  • Careers
  • Products
  • Login

Valuing Target Companies

CFA® Exam, CFA® Exam Level 2, Corporate Finance

This lesson is part 7 of 9 in the course Mergers & Acquisitions

There are several widely employed methods for valuing a potential M&A target; it is not uncommon for acquirers and investment banks to employ all of them when evaluating the attractiveness of a merger.

  • Discounted Cash Flow (DCF) Analysis
  • Comparable Company Analysis
  • Comparable Transaction Analysis

Discounted Cash Flow (DCF) Analysis

This is a derivative of the Gordon Growth approach to valuing a company, where an acquirer may discount free cash flows to the firm (FCFF) to value a potential target.

  • FCFF is important because it incorporates contributions of all suppliers of capital – both debt and equity.
  • DCF analysis attempts to determine the intrinsic value of the firm (i.e. the net present value of expected future cash flows).
  • By breaking down the cash flows, DCF analysis allows for an analyst to estimate the potential value created by synergies.
  • DCF analysis can be challenging because valuation relies on a number of estimates and assumptions that might not be fully known.
  • Candidates should review the steps of a DCF valuation and practice them in preparation for the exam. This is also relevant to the Equity sessions.

Comparable Company Analysis

The analyst will evaluate a target within the context of a group of relevant peer firms.

  1. The analyst must compile a list of comparable companies; the list may go beyond just firms in the target’s industry, but include other companies of similar size and similar capital structure.
  2. The analyst must then select the appropriate equity and/or enterprise valuation metrics (note: enterprise metrics sum the value of debt and equity less cash and marketable securities).
  3. The analyst will then apply the selected valuation metrics to the target and its “comps.”
  4. The analyst will then calculate the takeover premium (per share), which is the excess of the merger price per share over the pre-merger market price per share of equity divided by the pre-merger price per share.
  5. The analyst will then evaluate the takeover premium within the context of the comparable company valuations to determine a possible acquisition price.

Comparable Transaction Analysis

This method allows for the direct estimation of a target’s value by observing prices from recent acquisitions.

  1. The analyst identifies transactions that are comparable for the target in question. In this method, industry similar transactions are preferred.
    • For example, if an analyst is looking at a potential software company merger, he/she would not review recent bank acquisition prices.
  2. Just like in a comparable company analysis, the analyst will identify valuation metrics.
  3. The analyst will then apply the valuation metrics to the target firm.
    • For example, if an analyst is looking at a potential software company merger, he/she would not review recent bank acquisition prices.

This method is very attractive for evaluating M&A actions, but it can be very difficult to find truly comparable transactions and a number of adjustments may need to be made to the “comparable” transactions used in the analysis to make them relevant to the target in question.

Previous Lesson

‹ Herfindahl-Hirschman Index (HHI)

Next Lesson

Merger Gains to Shareholders & Post Merger Valuation ›

Join Our Facebook Group - Finance, Risk and Data Science

Posts You May Like

How to Improve your Financial Health

CFA® Exam Overview and Guidelines (Updated for 2021)

Changing Themes (Look and Feel) in ggplot2 in R

Coordinates in ggplot2 in R

Facets for ggplot2 Charts in R (Faceting Layer)

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Primary Sidebar

In this Course

  • Overview of Mergers & Acquisitions
  • M&A: Earnings Per Share & The “Bootsrap” Effect
  • Industry Lifecycle Phase and M&A
  • Pre-Offer Defense Takeover Mechanisms
  • Post-Offer Defense Takeover Mechanisms
  • Herfindahl-Hirschman Index (HHI)
  • Valuing Target Companies
  • Merger Gains to Shareholders & Post Merger Valuation
  • Types of Restructuring

Latest Tutorials

    • Data Visualization with R
    • Derivatives with R
    • Machine Learning in Finance Using Python
    • Credit Risk Modelling in R
    • Quantitative Trading Strategies in R
    • Financial Time Series Analysis in R
    • VaR Mapping
    • Option Valuation
    • Financial Reporting Standards
    • Fraud
Facebook Group

Membership

Unlock full access to Finance Train and see the entire library of member-only content and resources.

Subscribe

Footer

Recent Posts

  • How to Improve your Financial Health
  • CFA® Exam Overview and Guidelines (Updated for 2021)
  • Changing Themes (Look and Feel) in ggplot2 in R
  • Coordinates in ggplot2 in R
  • Facets for ggplot2 Charts in R (Faceting Layer)

Products

  • Level I Authority for CFA® Exam
  • CFA Level I Practice Questions
  • CFA Level I Mock Exam
  • Level II Question Bank for CFA® Exam
  • PRM Exam 1 Practice Question Bank
  • All Products

Quick Links

  • Privacy Policy
  • Contact Us

CFA Institute does not endorse, promote or warrant the accuracy or quality of Finance Train. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

Copyright © 2021 Finance Train. All rights reserved.

  • About Us
  • Privacy Policy
  • Contact Us