Business Valuation and Mergers & Acquisitions
This domain tests whether you can value a target using more than one method, quantify synergies and control, and structure a deal without overpaying.
Core rules
- DCF: enterprise value = PV of FCFF + PV of terminal value; terminal value = FCFF(n+1)/(WACC − g), with g below WACC and usually below nominal GDP growth.
- Equity value = enterprise value − net debt and other claims. Do not mix FCFF with equity value.
- Relative valuation: EV/EBITDA is capital-structure neutral; P/E is affected by leverage and accounting; P/B suits financial firms.
- Synergy value = combined value − (acquirer value + target value); only synergies net of integration costs belong in the bid.
- A control premium is paid for control; if DCF cash flows already assume control, do not add a premium again.
- Merger swap ratio = target value per share ÷ acquirer value per share.
Worked example
FCFF next year is ₹120 crore, g is 5%, WACC is 11%. Terminal value at end of year 1 = 120 × 1.05/(0.11 − 0.05) = ₹2,100 crore. PV = (120 + 2,100)/1.11 = ₹2,000 crore. If net debt is ₹300 crore, equity value = ₹1,700 crore. Reasoning: the terminal value is at the end of year 1, so it is discounted once; adding it to year-1 FCFF and discounting once is equivalent to separate discounting.
Traps
Using g greater than WACC; applying a control premium twice; deducting net debt from equity value; ignoring non-operating assets; treating synergy gains as free while ignoring integration costs; using the acquirer's P/E for a lower-growth target without justification.