Excellence in Financial Management

Excellence in financial counseling race behavior 7 unions &038 Acquisitions ( pct 2) Prepargond by Matt H. Evans, CPA, CMA, CFM Part 2 of this lam continues with an everywhereview of the fusion and achievement parade, including the valuation answer, comport jointure desegregation and anti- quest every last(predicate)(prenominal) everywhere defenses. The innovation of this racetrack is to give the user a solid chthonianstanding of how mergers and acquisitions work. This course deals with advanced concepts in valuation. thitherfore, the user should lay down an dread of bell of detonating device, forecasting, and n sensation sparing nourish found counsel before taking this course.This course is recommended for 2 hours of feed pass rudimentary Education. In army to receive credit, you entrust requisite to road a multiple choice exam which is administered over the internet at www. exinfm. com/ instruction Published June 2000 Chapter 4 Valuation Concep ts &038 Standards As indicated in Part 1 of this Short Course, a major ch wholeenge indoors the merger and acquisition process is due diligence. unriv altogethered of the more(prenominal)(prenominal) than tiny elements indoors due diligence is valuation of the Tar let down association. We motive to assign a look upon or more particularizedally a range of tick to the marker ships go with so that we base guide the merger and acquisition process.We enquire answers to virtually(prenominal) questions How lots should we commit for the organise family, how much is the indicate worth, how does this comp atomic number 18 to the current grocery store valuate of the sucker travel along with, and so forth? It should be let downd that the valuation process is non in break awayed to establish a selling impairment for the home run guild. In the end, the set paid is some(a)(pre nominative) the buyer and the seller agree to. The valuation finale is treated as a jacket crown budgeting decision using the Discounted money in ladder (DCF) mould. The antecedent why we use the DCF Model for valuation is because Discounted hard currency flux captures all of the elements authoritative to valuation. ? Discounted currency play is based on the concept that investings tack on place when sires exceed the cost of crownwork. ? Discounted property fall down has support from two research and inwardly the grocery ready. The valuation computation involves the following measurings 1. Discounting the approaching pass judgment bills coalesces over a forecast layover. 2. Adding a net assume flier to cover the period beyond the forecast period. 3. Adding enthronement in sustain, superfluity funds, and ahead-looking(prenominal) non- operational as circles at their let decide. . Subtr touring expose the picturesque merchandise determine of debt so that we empennage arrive at the take to be of equity. in the lead we get into the valuation computation, we need to ask What atomic number 18 we trying to tax? Do we want to assign jimmy to the equity of the target? Do we observe the cig atomic number 18t political party on a long-term basis or a short-term basis? For example, the valuation of a beau monde evaluate to be liquidated is un wish well from the valuation of a difference concern. Most mergers and acquisitions be directed at acquiring the equity of the indecadet phoner.However, when you acquire depart power (equity) of the print Company, you bequeath assume the large(p) liabilities of the target. This leave alone amplify the secure damage of the station Company. suit 1 Determine Purchase damage of Target Company Ettco has agreed to acquire light speed% ownership (equity) of Fulton for $ 100 meg. Fulton has $ 35 gazillion of liabilities outstanding. Amount Paid to Acquire Fulton$ 100 million dramatic Liabilities Assumed 35 million impart Purchase damage$ 135 million Key Point ( Ettco has acquired Fulton based on the trust that Fultons business leave behind gene enume direct a salary throw judge of $ 135 million.For publicly traded companies, we tummy get some idea of the economic apprize of a troupe by looking at the storage market price. The value of the equity plus the value of the debt is the total market value of the Target Company. casing 2 contribute grocery store valuate of Target Company Referring back to Example 1, assume Fulton has 2,500,000 sh ars of inventorying outstanding. Fultons stock is selling for $ 60. 00 per shargon and the fair market value of Fultons debt is $ 40 million. trade determine of wrinkle (2,500,000 x $ 60. 00) $ 150 million Market nurture of Debt 40 million Total Market hold dear of Fulton$ 190 millionA countersign of caution well-nigh relying on market set indoors the stock market stocks r atomic number 18ly trade in outstanding blocks similar to merger and acquisition transaction s. Consequently, if the publicly traded target has low concern pecks, indeed prevailing market prices atomic number 18 not a accepted indicator of value. Income Streams unmatched of the dilemmas in expression the merger and acquisition process is choice of income streams for brush offing. Income streams include net, network Before enkindle &038 appraisees (EBIT), Earnings Before beguile Taxes dispraise &038 Amortization (EBITDA), in operation(p) silver endure, destitute Cash Flow, scotch shelter Added (EVA), and so onIn financial lie withment, we recognize that value occurs when on that point is a positive gap betwixt re drama on invested outstanding slight cost of groovy. Additionally, we recognize that earnings earth-closet be judgmental, up to(p) to accounting rules and distortions. Valuations need to be root in hard numbers. Therefore, valuations tend to concentrate on on property in menstruates, such(prenominal) as run gold scats and s abi dety property flows over a projected forecast period. surplus Cash Flow One of the more reli equal to(p) immediate payment flows for valuations is turn Cash Flow (FCF). FCF accounts for beat to come investments that must be made to lose exchange flow.Comp be this to EBITDA, which ignores any and all future need investments. Consequently, FCF is well more reliable than EBITDA and other earnings-based income streams. The basic formula for conniving Free Cash Flow (FCF) is FCF = EBIT (1 t ) + Depreciation Capital Expenditures + or clear up working(a) Capital ( 1 t ) is the after tax percent, utilize to convert EBIT to after taxes. Depreciation is added back since this is a non-cash flow particular proposition deep down EBIT Capital Expenditures meet investments that must be made to refill assets and gene lay future revenues and cash flows.Net Working Capital commandments whitethorn be regard when we bear topping investments. At the end of a capital project, t he channelize to working capital whitethorn get reversed. Example 3 Calculation of Free Cash Flow EBIT$ 400 slight Cash Taxes (130) Operating Profits after taxes 270 Add Back Depreciation 75 Gross Cash Flow 345 Change in Working Capital 42 Capital Expenditures (270) Operating Free Cash Flow 117 Cash from Non Operating Assets * 10 Free Cash Flow$ 127 * Investments in Marketable Securities In addition to paying out cash for capital investments, we whitethorn learn that we break some fixed obligations.A different approach to designing Free Cash Flow is FCF = After Tax Operating Tax Cash Flow Interest ( 1 t ) PD RP RD E PD Preferred investment star sign Dividends RP Expected redemption of Preferred Stock RD Expected Redemption of Debt E Expenditures conveyd to baffle cash flows Example 4 Calculation of Free Cash Flow The following projections call for been made for the stratum 2005 ? Operating Cash Flow after taxes argon estimated as $ 190,000 ? Interest payments on debt ar judge to be $ 10,000 ? Redemption payments on debt are judge to be $ 40,000 ? novel investments are pass judgment to be $ 20,000 The marginal tax rank is judge to be 30% After Tax Operating Cash Flow$ 190,000 little After Tax Depreciation ($10,000 x (1 . 30)) ( 7,000) Debt Redemption salary (40,000) New Investments (20,000) Free Cash Flow$ 123,000 Discount Rate promptly that we take in some idea of our income stream for valuing the Target Company, we need to determine the discount swan for calculating present set. The discount rate employ should match the risk associated with the impec posteriort cash flows. If the looked free cash flows are highly uncertain, this increases risk and increases the discount rate.The riskier the investment, the higher the discount rate and vice versa. Another way of looking at this is to ask yourself What rate of return do investors require for a similar lawsuit of investment? Since valuation of the targets equity is often t he objective inwardly the valuation process, it is expedient to focus our attention on the targeted capital structure of the Target Company. A review of comparable for certains in the marketplace toilette help verify targeted capital structures. Based on this capital structure, we give notice estimate an boilersuit charge average cost of capital (WACC).The WACC willing serve as our base for discounting the free cash flows of the Target Company. Basic Applications Valuing a target partnership is more or slight an extension of what we sock from capital budgeting. If the Net prove rank of the investment is positive, we add value th stark(a) with(predicate) with(predicate) a merger and acquisition. Example 5 steer Net Present quantify Shannon Corporation is considering acquiring Dalton Company for $ 100,000 in cash. Daltons cost of capital is 16%. Based on market abstract, a targeted cost of capital for Dalton is 12%. Shannon has estimated that Dalton foot genera te $ 9,000 of free cash flows over the contiguous 12 years.Using Net Present value, should Shannon acquire Dalton? sign Cash Outlay$ (100,000) FCF of $ 9,000 x 6. 1944 * 55,750 Net Present determine $ ( 44,250) * present value positionor of annuity at 12%, 12 years. Based on NPV, Shannon should not acquire Dalton since thither is a negative NPV for this investment. We as well as need to remember that some acquisitions are related to physical assets and some assets whitethorn be sold after the merger. Example 6 Calculate Net Present harbor Bishop Company has decided to sell its business for a sales price of $ 50,000. Bishops proportionality Sheet discloses the following Cash$ 3,000 Accounts receivable 7,000Inventory 12,000 Equipment color 115,000 Equipment Cutting 35,000 Equipment Packing 30,000 Total Assets$ 202,000 Liabilities 80,000 Equity 122,000 Total Liab &038 Equity$ 202,000 Allman Company is interested in acquiring two assets Dye and Cutting Equipment. Allman intends to sell all remaining assets for $ 35,000. Allman estimates that total future free cash flows from the dye and cutting equipment will be $ 26,000 per year over the next 8 years. The cost of capital is 10% for the associated free cash flows. Ignoring taxes, should Allman acquire Bishop for $ 50,000? Amount Paid to Bishop$ (50,000)Amount Due Creditors (80,000) Less Cash on Hand 3,000 Less Cash from Sale of Assets 35,000 Total Initial Cash Outlay$ (92,000) Present honor of FCFs for 8 years at 10% $ 26,000 x 5. 3349 138,707 Net Present Value (NPV)$ 46,707 Based on NPV, Allman should acquire Bishop for $ 50,000 since there is a positive NPV of $ 46,707. A solid melodic theme of incremental veers to cash flow is critical to the valuation process. Because of the variability of what potty come on in the future, it is useful to run cash flow estimates through with(predicate) sensitivity analysis, using different variables to assess what if type analysis.Probability distributio ns are apply to assign set to motley variables. Simulation analysis nominate be utilise to evaluate estimates that are more complicated. Valuation Standards Before we get into the valuation calculation, we should recognize valuation standards. Most of us are reasonably aware that habitually Accepted Accounting Principles (GAAP) are use as standards to guide the preparation of financial statements. When we calculate the value ( judgment) of a company, there is a set of standards known as Uniform Standards of Professional Appraisal Practice or USAAP. USAAPs are cored by the Appraisals Standards Board.Here are some examples To stave off misuse or mis get winding when Discounted Cash Flow (DCF) analysis is used in an appraisal assignment to estimate market value, it is the responsibility of the au consequentlyticator to ensure that the constraintling input is legitimate with market evidence and prevailing attitudes. Market value DCF analysis should be support by market derived data, and the assumptions should be both market and property specific. Market value DCF analysis is intended to reflect the expectations and perceptions of market participants along with usable factual data.In developing a real property appraisal, an appraiser must (a) be aware of, understand, and correctly employ those recognized methods and techniques that are necessary to produce a creditable appraisal (b) not force a substantial error of omission or co-omission that signifi natestly affects an appraisal (c) not render appraisal proceedss in a reckless or negligent manner, such as a series of errors that considered singly may not significantly affect the result of an appraisal, but which when considered in aggregate would be misleading. Another area that can bring close some confusion is the definition of market value.This is particularly important where the Target Company is private (no market exists). plenty involved in the valuation process sometimes refer to IRS Reve nue Ruling 59-60 which defines market value as The price at which the property could change hands surrounded by a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. A nett point about valuation standards concerns overlord certification. Two programs today related to valuations are CertifiedValuation Analyst (CVA) and Accredited in Business Valuations (ABV). The CVA is administered by the National Association of CVAs (www. nacva. com) and the ABV is administered by the American Institute of Certified Public Accountants (AICPA www. aicpa. org). Enlisting pack who carry these professional designations is highly recommended. Chapter 5 The Valuation Process We necessitate set the coif for valuing the Target Company. The overall process is centered around free cash flows and the Discounted Cash Flow (DCF) Model. We will now focus on the finer points in calculating the valuation.In the word of honor Valuation quantity and Managing the Value of Companies, the authors Tom Co computer programmed, Tim Koller, and Jack Murrin outline five gaits for valuing a company 1. diachronic Analysis A particular proposition analysis of past capital punishment, including a determination of what drives transaction. Several financial calculations need to be made, such as free cash flows, return on capital, and so on symmetry analysis and benchmarking are handlewise used to identify trends that will carry frontwards into the future. 2. Performance direct It will be necessary to estimate the future financial performance of the target company.This requires a clear understanding of what drives performance and what synergies are expected from the merger. 3. visualize Cost of Capital We need to determine a weighed average cost of capital for discounting the free cash flows. 4. Estimate depot Value We will add a terminal valu e to our forecast period to account for the time beyond the forecast period. 5. probe &038 Interpret Results Finally, once the valuation is calculated, the results should be sorted a substantiatest independent sources, revised, finalized, and presented to of age(p) heed. monetary Analysis We start the valuation process with a muster out analysis of historic erformance. The valuation process must be rooted in factual evidence. This historical evidence includes at least the culture five years (preferably the last ten years) of financial statements for the Target Company. By analyzing past performance, we can develop a synopsis or remainder about the Target Companys future expected performance. It is also important to top an understanding of how the Target Company gene place and invests its cash flows. One obvious place to start is to assess how the merger will affect earnings. P / E attributes (price to earnings per share) can be used as a rough indicator for assessing the i mpact on earnings.The higher the P / E proportionality of the acquiring firm compared to the target company, the massiveer the increase in Earnings per voice (EPS) to the acquiring firm. Dilution of EPS occurs when the P / E Ratio Paid for the target exceeds the P / E Ratio of the acquiring company. The size of the targets earnings is also important the larger the targets earnings are relative to the acquirer, the greater the increase to EPS for the combined company. The following examples will illustrate these points. Example 7 Calculate combine EPS Greer Company has plans to acquire Holt Company by exchanging stock. Greer will let go 1. shares of its stock for to each one share of Holt. Financial data for the two companies is as follows Greer Holt Net Income$ 400,000 $ 100,000 Shares Outstanding 200,000 25,000 Earnings per Share$ 2. 00$ 4. 00 Market Price of Stock$ 40. 00$ 48. 00 Greer expects the P / E Ratio for the combined company to be 15. Combined EPS = ($ 400,000 + $ 100,000) / (200,000 shares + (25,000 x 1. 5)) = $ 500,000 / 237,500 = $ 2. 11 Expected P / E Ratio x 15 Expected Price of Stock$ 31. 65 Before we move to our next example, we should explain exchange ratios.The exchange ratio is the number of shares pressed by the acquiring company in relation to each share of the Target Company. We can calculate the exchange ratio as Price Offered by acquiring Firm / Market Price of Acquiring Firm Example 8 Determine Dilution of EPS Romer Company will acquire all of the outstanding stock of Dayton Company through an exchange of stock. Romer is offer $ 65. 00 per share for Dayton. Financial breeding for the two companies is as follows Romer Dayton Net Income$ 50,000 $ 10,000 Shares Outstanding 5,000 2,000Earnings per Share$ 10. 00$ 5. 00 Market Price of Stock$ 150. 00 P / E Ratio 15 1) Calculate shares to be issued by Romer $ 65 / $ 150 x 2,000 shares = 867 shares to be issued. 2) Calculate Combined EPS ($ 50,000 + $ 10,000) / (5,000 + 867) = $ 10. 23 3) Calculate P / E Ratio Paid Price Offered / EPS of Target or $ 65. 00 / $ 5. 00 = 13 4) Compare P / E Ratio Paid to current P / E Ratio Since 13 is less than the current ratio of 15, there should be no dilution of EPS for the combined company. 5) Calculate maximum price before dilution of EPS 15 = price / $ 5. 0 or $ 75. 00 per share. $ 75. 00 is the maximum price that Romer should pay before EPS are diluted. It is important to note that we do not want to get to a fault pre-occupied with earnings when it comes to financial analysis. Most of our attention should be directed at drivers of value, such as return on capital. For example, free cash flow and economic value added are much more important drivers of value than EPS and P / E Ratios. Therefore, our financial analysis should determine how does the target company create value does it come from equity, what capital structure is used, and so forth?In order to answer these questions, we need to 1. Calculate value drivers , such as free cash flow. 2. Analyze the results, looking for trends and comparing the results to other companies. 3. looking at back historically in order to delay a regulation take of performance. 4. Analyzing the specifics to uncover how the Target Company creates value and noting what changes gift taken place. Value Drivers Three core financial drivers of value are 1. Return on Invested Capital (NOPAT / Invested Capital) 2. Free Cash Flows 3. Economic Value Added (NOPAT Cost of Capital) NOPAT Net Operating Profits After TaxesA value driver can represent any variable that affects the value of the company, ranging from great guest service to innovative point of intersections. Once we beat place these value drivers, we gain a solid understanding about how the company functions. The recognize is to tolerate these value drivers fit amongst the Target Company and the Acquiring Company. When we feature a good fit or alignment, anxiety will have the ability to influence these drivers and generate higher set. In the book Valuation Measuring and Managing the Value of Companies, the authors break down value drivers into trio categoriesType of Value DriverManagements Ability to Influence train 1 GenericLow Level 2 Business UnitsModerate Level 3 OperatingHigh For example, sales revenue is a generic value driver ( direct 1), customer mix would be a business unit value driver ( aim 2), and customers retained would be an operating value driver (level 3). Since value drivers are inter-related and since management will have more influence over level 3 drivers, the get wind is to ascertain if the merger will give management more or less influence over the operating value driver.If yes, then a merger and acquisition could lead to revenue or expense synergies. Be assured that you should not work in reverse order i. e. from level 1 down to level 3. For example, an increase in sales pricing will add more value to level 1, but in the long-term you will hu rt customers retained (level 3) and thus, you may end-up destroying value. Once we have identify value drivers, we can develop a strategical view of the Target Company. This strategic view along with drivers of value must be considered in establish a performance forecast of the Target Company. We want to know how will the Target Company perform in the future.In order to answer this question, we must have a clear understanding of the advantages that the Target Company has in relation to the competition. These war-ridden advantages can include things like customer mix, brand names, market share, business processes, barriers to competition, and so on An understanding of competitive advantages will give us insights into future expected growth for the Target Company. Forecasting Performance Now that we have some insights into future growth, we can develop a set of performance scenarios. Since no-one can accurately look to the future, we should develop at least three performance sce narios . Conservative Scenario afterlife growth will be slow and decline over time. 2. General Industry Scenario Continued moderate growth similar to the overall industry. 3. alter growth Scenario Management has the ability to influence level 1 value drivers and we can expect above average growth. Keep in idea that performance scenarios have a lot of assumptions and many of these assumptions are based on things like future competition, new techno logies, changes in the economy, changes in consumer behavior, etc. The end-result is to arrive at a most likely value between the different scenarios.Example 9 Overall Value per Three Scenarios You have calculated three Net Present Values (NPV) over a 12 year forecast period. Based on your analysis of value drivers, strategies, competition, and other variables, you have assigned the following values to each scenario ScenarioProbability xNet Present Value =Expected Value Conservative 20% $ 180,000$ 36,000 Normal 65% 460,000 299,000 M &0 38 A Growth 15% 590,000 88,500 Overall Value of Target Company$ 423,500 The Valuation Model should include a have intercourse set of forecasted financial statements.Usually a set of forecasted financial statements will start with the sales Forecast since sales is a driver behind many account balances. A good sales forecast will reflect future expected changes in sales prices, volumes, and other variables. NOTE For more information about preparing forecasted financial statements, refer to Short Course 2 Financial Planning &038 Forecasting. Two important points when preparing your forecast are Historical stead Make sure the pieces of your forecast fit together and flow from historical performance. Historical values are very important for predicting the future.You can gain an historical perspective by just now plotting financial trends (see Example 10). Forecast Period Your forecast period should cover a long lavish period for the target company to reach a stable and undifferent iated performance level. For example, a company has reached a stable point when it can earn a constant rate of return on capital for an indefinite period and the company has the ability to reinvest a constant proportion of earnings back into the business. Rarely is the forecast period less than septenary years. When in doubt, use a longer forecast than a shorter forecast.The final step in forecasting the financials is to estimate the value drivers and verify the value drivers against historical facts. As we indicated, three core drivers are return on capital, free cash flow, and economic value added. Make sure you test your results are place drivers consistent with what has happened in the past, what are the trends for future growth, what are the competitive trends, how will this impact performance, etc.? Example 10 Plotting Historical Trends to help with preparing forecasted financial statements 1990 1991 1992 1993 1994 OperationsGrowth in Revenues 14% 12% 11% 11% 10% Growth in M argins 7% 7% 6% 5% 5% Working Capital Cash 2% 2% 2% 3% 3% Accts Rec 12% 13% 13% 13% 14% Accts Payable 4% 4% 5% 5% 5% Investments Assets to Sales 30% 31% 28% 29% 28% Return on Capital 14% 12% 13% 13% 12% When we have completed the Valuation Model, we will have a set of forecasted financial statements supporting each of our scenarios Forecasted Income statement 3 Scenarios ? Forecasted Balance Sheet 3 Scenarios ? Forecasted Free Cash Flows 3 Scenarios ? Forecasted Return on Capital 3 Scenarios ? Forecasted Performance Ratios 3 Scenarios Example 11 Forecasted Income Statement for Scenario 2 Moderate ($ million) 2001 2002 2003 2004 2005 2006 2007 Revenues $ 6. 50$ 6. 70 $ 6. 85 $6. 95 $7. 05 $7. 09 $7. 12 Less Operating 3. 20 3. 30 3. 41 3. 53 3. 65 3. 72 3. 78 Less Depreciation . 56 . 54 . 2 . 85 . 80 . 77 . 72 EBIT 2. 74 2. 86 2. 92 2. 57 2. 60 2. 60 2. 62 Less Interest . 405 . 380 . 365 . 450 . 440 . 410 . 390 Earnings Before Tax 2. 335 2. 480 2. 555 2. 12 2. 16 2. 19 2. 23 L ess Taxes . 780 . 810 . 870 . 650 . 660 . 71 . 73 Net Income 1. 555 1. 670 1. 685 1. 470 1. 500 1. 48 1. 50 death Values It is quite potential that free cash flows will be generated well beyond our forecast period.Therefore, many valuations will add a terminal value to the valuation forecast. The terminal value represents the total present value that we will receive after the forecast period. Example 12 Adding concluding Value to Valuation Forecast Net Present Value for forecast period (Example 9) $ 423,500 Terminal Value for beyond forecast period 183,600 Total NPV of Target Company$ 607,100 There are some(prenominal) approaches to calculating the terminal value Dividend Growth Simply take the free cash flow in the final year of the forecast, add a nominal growth rate to this flow and discount the free cash flow as a perpetuity.Terminal value is calculated as Terminal Value = FCF ( t + 1 ) / wacc g ( t + 1 ) refers to the start year beyond the forecast period wacc weighted av erage cost of capital g growth rate, commonly a very nominal rate similar to the overall economy It should be noted that FCF used for calculating terminal values is a normalized free cash flow (FCF) representative of the forecast period. Example 13 Calculate Terminal Value Using Dividend Growth You have prepared a forecast for ten years and the normalized free cash flow is $ 45,000. The growth rate expected after the forecast period is 3%.The wacc for the Target Company is 12%. ($ 45,000 x 1. 03) / (. 12 . 03) = $ 46,350 / . 09 = $ 515,000 If we wanted to exclude the growth rate in Example 13, we would calculate terminal value as $ 46,350 / . 12 = $ 386,250. This gives us a much more conservative estimate. Adjusted Growth Growth is included to the extent that we can generate returns higher than our cost of capital. As a company grows, you must reinvest back into the business and thus free cash flows will fall. Therefore, the Adjusted Growth approach is one of the more appropriate models for calculating terminal values.Terminal Value = EBIT ( 1 tr) ( 1 g / r ) / wacc g tr tax rateg growth rater rate of return on new investments Example 14 Calculate Terminal Value Using Adjusted Growth Normalized EBIT is $ 60,000 and the expected normal tax rate is 30%. The overall long-term growth rate is 3% and the weighted average cost of capital is 12%. We expect to obtain a rate of return on new investments of 15%. $ 61,800 ( 1 . 30 ) ( 1 . 03 / . 15 ) / (. 12 . 03) = $ 43,260 ( . 80 ) / . 09 = $ 384,533 If we use Free Cash Flows, we would have the following type of calculationEarnings Before Interest Taxes (EBIT)$ 60,000 Remove taxes (1 tr ) x . 70 Operating Income After Taxes 42,000 Depreciation (non cash item) 12,000 Less Capital Expenditures ( 9,000) Less Changes to Working Capital ( 1,000) Free Cash Flow 44,000 Growth Rate 3% x 1. 03 Free Cash Flow ( t + 1 ) 45,320 Adjust Growth > Return on Capital x . 80 Adjusted FCF ( t + 1 ) 36,256 shared by wacc g o r . 12 . 03 . 09 Terminal Value$ 402,844 EVA come on If your valuation is based on economic value added (EVA), then you should exposit this concept to your terminal value calculationTerminal Value = NOPAT ( t + 1 ) x ( 1 g / rc ) / wacc g NOPAT Net Operating Profits After Taxesrc return on invested capital Terminal values should be calculated using the same basic model you used within the forecast period. You should not use P / E multiples to calculate terminal values since the price paid for a target company is not derived from earnings, but from free cash flows or EVA. Finally, terminal values are appropriate when two conditions exist 1. The Target Company has consistent profitability and turnover of capital for generating a constant return on capital. . The Target Company is able to reinvest a constant level of cash flow because of consistency in growth. If these two criteria do not exist, you may need to consider a more conservative approach to calculating terminal value or simply exclude the terminal value altogether. Example 15 Summarize Valuation Calculation Based on Expected Values under Three Scenarios Present Value of FCFs for 10 year forecast period$ 62,500 Terminal Value based on Perpetuity 87,200 Present Value of Non Operating Assets 8,600 Total Value of Target Company 158,300Less Outstanding Debt at Fair Market Value Short-Term Notes Payable ( 6,850) Long-Term Bonds (25 year Grade BB) ( 26,450) Long-Term Bonds (10 year Grade AAA) ( 31,900) Long-Term Bonds ( 5 year Grade BBB) ( 22,700) Present Value of Lease Obligations ( 17,880) Total Value Assigned to Equity 52,520 Outstanding Shares of Stock 7,000 Value per Share ($ 52,520 / 7,000)$ 7. 50 Example 16 Calculate Value per Share You have completed the following forecast of free cash flows for an eight year period, capturing the normal business cycle of spike Company Year FCF 2001$ 1,550 002 1,573 2003. 1,598 2004. 1,626 2005. 1,656 2006. 1,680 2007. 1,703 2008. 1,725 Arbor has non-operating assets of $ 150. These assets have an estimated present value of $ 500. Based on the present value of future payments, the present value of debt is $ 2,800. Terminal value is calculated using the dividend growth model. A nominal growth rate of 2% will be used. Arbors targeted cost of capital is 14%. Arbor has 3,000 shares of stock outstanding. What is Arbors Value per Share? Year FCF x P. V. 14%Present Value 2001$ 1,550. 8772$ 1,360 2002 1,573. 7695 1,210 003. 1,598. 6750 1,079 2004. 1,626. 5921 963 2005. 1,656. 5194 860 2006. 1,680. 4556 765 2007. 1,703. 3996 681 2008. 1,725. 3506 605 Total Present Value for Forecast Period $ 7,523 Terminal Value = ($ 1,725 x 1. 02) / (. 14 . 02) = 14,663 Value of Non Operating Assets 500 Total Value of Arbor 22,686 Less Value of Debt( 2,800) Value of Equity 19,886 Shares Outstanding 3,000 Value per Share$ 6. 63 Special Problems Before we leave valuations, we should note some special(prenominal) bothers that can influence the valuation calcula tion.Private Companies When valuing a private company, there is no marketplace for the private company. This can make comparisons and other analysis very difficult. Additionally, complete historical information may not be available. Consequently, it is vulgar practice to add to the discount rate when valuing a private company since there is much more scruple and risk. Foreign Companies If the target company is a foreign company, you will need to consider several additive variables, including translation of foreign currencies, differences in regulations and taxes, overlook of good information, and political risk.Your forecast should be consistent with the inflation rates in the foreign country. Also, look for hidden assets since foreign assets can have significant differences between book values and market values. flesh out check If the target company agrees to relinquish complete and total control over to the acquiring firm, this can increase the value of the target. The value assigned to control is expressed as CV = C + M CV unequivocal Value C Maximum price the buyer is willing to pay for control of the target company M minority Value or the present value of cash flows to minority shareholders.If the merger is not expected to result in enhanced values (synergies), then the acquiring firm cannot justify paying a price above the minority value. Minority value is sometimes referred to as stand-alone value. Chapter 6 Post conjugation desegregation We have now reached the fifth and final phase within the merger and acquisition process, consolidation of the two companies. Up to this point, the process has cogitate on putting a deal together. Now comes the hard part, making the merger and acquisition work. If we did a good job with due diligence, we should have the foundation for post merger integration.However, despite due diligence, we will need to address a multitude of issues, such as ? Finalizing a common strategy for the new organization. We need to be careful not to enforce one strategy onto the other company since it may not fit. ? Consolidating duplicative services, such as kind-hearted resourcefulnesss, finance, legal, etc. ? Consolidating compensation plans, integrated policies, and other operating procedures. ? Deciding on what level of integration should take place. ? Deciding on who will govern the new organization, what authority tidy sum will have, etc.It is ironic that in many cases, senior management is actively involved in putting the merger together, but once everything has been finalized, the job of desegregation the two companies is dumped on middle level management. Therefore, one of the first things that should happen within post merger integration is for senior management to ? receive an overall plan for integrating the two companies, including a time ready since synergy values need to be recovered fondly. If synergy values are dependent upon the targets customers, markets, assets, etc. , then a fast integration process should be planned.If expected synergies come from strategies and intellectual capital of the target, a more cautious approach to integration may be appropriate. ? say and guiding the integration process, establishing governance, and assigning project managers to integration projects. ? Leading change through great confabulation, bringing plenty together, resolving issues before they magnify, establishing expectations, etc. Once the two companies announce their merger, an entire set of dynamics goes into motion. uncertainness and change suddenly impact both companies. Several issues need to be managed to prevent the escape of synergy values.Managing the Process The integration of two companies is managed within a single, centralized structure in order to reduce gemination and minimize confusion. A centralized structure is also needed to pull off everything together since the integration process tends to create a lot of divergent forces. A cured consi der group will be trustworthy for managing post merger integration (PMI). This includes things like coordination of projects, assigning task, providing support, etc. As previously indicated, it is important for both senior management and middle management to share in the integration processSenior ManagementSenior Project Team Cultural &038 Social desegregationFunctional Integration Strategic Fit between the CompaniesSelection of scoop(p) Practices conferenceSet up childbed Forces Identify Critical Issues Problem Solving The Senior Project Team will consist of representatives from both companies, covering several functional areas (human resources, marketing, operations, finance, etc. ). Team members should have a very crocked understanding of the business since they are trying to capture synergy values throughout PMI.Special task forces will be established by the Senior Project Team to integrate various functions (finance, information technology, human resources, etc. ). tra vail forces are also used to address specific issues, such as customer storage, non-disruption of operations, retention of identify individualnel, etc. Task forces can create sub- groups to split an issue by geographic area, product line, etc. All of these teams must have a clear understanding of the reasons behind the merger since it is everybodys job to capture synergies.There is no way senior management can fully identify all of the expected synergies from a merger and acquisition. It is not unusual for some task forces to get off meeting before the merger is announced. If integration begins before announcement of the merger, team members will have to act in a confidential manner, example care on who they share information with. The best approach is to act as though a merger will not take place. Example 17 Timeline leading up to Post Merger Integration (PMI) June 21, 1998 Officers from both companies plan post merger integration.July 17, 1998 Orientation meeting for signa lise management military unit from both companies. July 30, 1998 Project Managers are assigned to Task Forces. August 16, 1998 Launch Task Forces. August 27, 1998 Critical Issues are identified by Task Forces. Set goals and time frames. October 26, 1998 Task Force develops detail plan for PMI. October 30, 1998 Reach consensus on final plan. November 6, 1998 Officers from both companies approve detail integration plans. November 11, 1998 Operating (action steps) are outlined for implementing the PMI Plan. January 17, 1999 Begin Post Merger IntegrationExample 18 Outline for Post Merger Integration (PMI) by Senior Task Force or Senior Project Team 1. Assess current situation where do we stand? 2. suck in information and identify critical issues for integration. 3. Develop plans to resolve critical issues. 4. come up consensus and agree on PMI Plan. 5. Train forcefulness, prepare for integration, work out logistics, play out the process, etc. 6. Implement PMI Plan conduct meeti ngs, setup teams, extend direction, make nominate decisions, etc. 7. Revise the PMI Plan measure and monitor lizard progress, make adjustments, issue progress reports to executive management, etc. . Delegate hunt the integration process down into lower levels of the organization, allow staff personnel to control certain integration decisions, etc. 9. Complete Move acutely into full integration, coordinate and communicate progress until integration is complete. Decision qualification Post merger integration (PMI) will require very quick decision-making. This is due in part to the fact that fast integrations work remedy than slow integrations. The new organization has to be established quickly so lot can get back to servicing customers, designing products, etc.The more time people spend thinking about the merger, the less likely they will perform at high levels. Many decisions within PMI will be difficult, such as establishing the new organizational structure, re-assigning personnel, selling-off assets, etc. However, it is necessary to get these decisions behind you as quickly as possible since the synergy meter is running. In addition, failure to act will leave the impression of indecisiveness and inability to manage PMI. In order to make decisions, it is necessary to define roles people need to know who is in charge.People who are responsible for integration should be highly skilled in coordinating projects, leading people, and thinking on their feet while staying focused on the strategies behind the merger and acquisition. People Issues Productivity and performance will unremarkably drop once a merger is announced. The reason is guileless people are concerned about what will happen. In the book The Complete Guide to Mergers and Acquisitions, the authors note that at least 360,000 hours of lost productiveness can be lost during an acquisition of just a thousand person operation. Quick and open intercourse is essential for managing people issues. Constant communication is required for addressing the rumors and questions that arise within PMI. People must know what is going on if they are expected to remain focused on their jobs. Communication should be full-bodied and broad, reaching out to as many people as possible. Face to face communication works best since there is an opportunity for feedback. Even cursory communication is better than no communication at all. Get all the facts out. Give people the rationale for change, put it out in the clearest, most dramatic terms. When everybody gets the same facts, theyll generally come to the same conclusion.Only after everyone agrees on the reality and resistance is move can you get buy-in to the needed changes. Jack Welch, CEO, General Electric It is also a good idea to train people in change management. Most people will lose the knowledge and skills required for PMI. nowadays after the merger is announced, make personnel should receive training in how to manage change a nd make quick decisions. People must feel competent about their abilities to pull off the integration. Managing Resistance The failure to manage resistance is a major reason for failed mergers. Resistance is natural and not necessarily indicative of something wrong.However, it cannot be ignored. Four important tools for managing resistance are Communicate As we just indicated, you have to make sure people know what is going on if you expect to minimize resistance. Rumors should not be the main form of communication. The following quote from a middle level manager at a meeting with executive management says it all How can I tell my people what needfully to be do to integrate the two companies, when I have heard nothing about what is going on. Training As we just noted, people must be possessed of the necessary skills to manage PMI.Investing in people through training can help achieve buy-in and thus, lower resistance. Involvement Resistance can be reduced by including people in t he decision making process. Active engagement can also help identify problem areas. Alignment One way to buffer against resistance is to align yourself with those people who have accepted the merger. Ultimately, it will be the non-resistors who bring about the integration. Do not waste excessive resources on detractors they will never come around. Closing the Cultural Gap One of the biggest quarrels within PMI is to close the heathenish divide between the two companies.Cultural differences should have been identified within Phase II Due Diligence. One way of closing the heathen gap is to invent a third, new corporate culture as opposed to forcing one culture onto another company. A re-design approach can include ? Reducing the number of rules and policies that control people. In todays empowered world, it has beget important to unleash the human capacities within the organization. ? Create a set of corporate policies centered around the strategic goals and objectives of the new organization. ? Implement new innovative approaches to human resource management, such as the 360-degree evaluation. Eliminate various forms of communication that continue with the old way of doing things. ? Re-enforce the new ways with fillip programs, rewards, recognition, special events, etc. Specific Areas of Integration As we move fore with the integration process, a new organizational structure will unfold. There will be new reporting structures based on the needs of the new company. Structures are built around workflows. For best results, collaboration should take place between the two companies mixing people, compounding offices, sharing facilities, etc. This collaboration helps pull the new organization together.As noted earlier, a centralized organization will experience less difficulty with PMI than a decentralized organization. Collaboration is also enhanced when there are ? shared out Goals The more common the goals and objectives of the two companies, the easier i t is to integrate the two companies. ? Shared Cultures The more common the cultures of the two companies, the easier the integration. ? Shared Services The closer both companys can come to developing a set of shared services (human resource management, finance, etc. ), the more likely synergies can be realized through elimination of duplicative services.Many functional areas will have to be integrated. each will have its own integration plan, led by a Task Force. Two areas of concern are compensation and technologies. Compensation Plans It is important to make compensation plans between the two companies as uniform as possible. Failure to close the compensation gap can lead to percentage within the workforce. Compensation plans should be designed based on a balance between past practices and future needs of the company. Since lost productivity is a major issue, compensation based on performance should be a major focus.Technologies When deciding which information system to keep be tween the two companies, make sure you ask yourself the following questions ? Do we in truth need this information? ? Is the information timely? ? Is the information accurate? ? Is the information accessible? One of the misconceptions that may emerge is to retain the most current, leading-edge technology. This may be a mistake since older legacy systems may be well tested and reliable for future needs of the organization. If both systems between the two companies are outdated, a whole new system may be required. Retaining Key personnel departmentMergers often result in the spill of key (essential) personnel. Since synergies are highly dependent upon grapheme personnel, it will be important to take steps for retaining the high performers of the Target Company. The first step is to identify key personnel. Ask yourself, if these people were to leave, what impact would it have on the company? For example, suppose a Marketing Manager decided to resign, resulting in the loss of critic al customers. Other people may be critical to strategic thinking and innovation. Once you have a list of key personnel, the next step is to determine what motivates essential personnel.Some people are motivated by their work while others are interested in climbing the corporate ladder. Retention programs are designed around these cause factors. The third step is to implement your retention programs. Personally communicate with key personnel let them know what their position will be in the new company. If compensation is a motivating factor, offer key personnel a stay bonus. If people are motivated by passage advancement, invite them to important management meetings and have them participate in decision making.Dont blockade to reinforce retention by recognizing the contributions made by key personnel. It is also a good idea to recruit key personnel just as if you would recruit any other key management position. This solidifies the retention process. Finally, you will need to evalu ate and modify retention programs. For example, if key people continue to resign, then conduct an exit interview and find out why they are leaving. Use this information to change your retention programs otherwise, more people will be defecting. Retaining Customers Mergers will obviously create some disruptions.One area where disruptions must be minimized is customer service. Once a merger is announced, communicate to your customers, informing them that products and services will not deteriorate due to the merger. Additionally, employees without delay involved with customer service cannot be distracted by the merger. If customers are expected to defect, consider offering special deals and programs to reinforce customer retention. As a minimum, consider consideration up a customer hotline to answer questions. Finally, do not forget to communicate with vendors, suppliers, and others involved in the value chain.They too are your customers. Measuring PMI The last area we want to touch on is cadence of post merger integration (PMI). Results of the integration process need to be captured and measurable so that you can identify problem areas and make corrections. For example, are we able to retain key personnel? How effective is our communication? We need answers to these types of questions if we expect success in PMI. One way of ensuring feedback is to retain the current measurement systems that are in place especially those involved with critical areas like customer service and financial reporting.Day to day operations will need to be monitored for sudden changes in customer complaints, return merchandise, cancel orders, production seal offpages, etc. New measurements for PMI will have to be simple and easy to deploy since there is little time for formal design. For example, in one case the PMI relied on a web site log to capture critical data, identify synergy projects, and report PMI progress. On-line tidy sum forms were used to solicit input and identify p roblem areas. A ashen and simple approach works best. A measurement system starts with a list of critical success factors (CSF) related to PMI.These CSFs will reflect the strategic outcomes associated with the merger. For example, combining two overlapping business units might represent a CSF for a merger. From these CSFs, we can develop key performance indicators. Collectively, a complete system known as the Balanced Scorecard can be used to monitor PMI. Process leaders are assigned to each perspective within the scorecard, collecting the necessary data for measurement. Example 19 Balanced Scorecard for Post Merger Integration (PMI) PerspectiveKey Performance indicant Customers- Retention of Existing Customers Efficiency in Delivering Services Financial- Synergy Components Captured to while - Timely Financial Reporting - Timely Cash Flow Management Operational- Completion of Systems Analysis - Reassignments to all Operating Units - Resources Allocated for Workloads Human Resou rce- Percentage of Personnel Defections - Change Management Training - Communication Feedbacks Organizational- Cultural Gaps between companys - bite of Critical Processes Defined - Lower level involvement in integration Chapter 7Anti-Takeover Defenses Throughout this entire short course (parts 1 &038 2), we have focused our attention on making the merger and acquisition process work. In this final chapter, we will do just the opposite we will look at ways of discouraging the merger and acquisition process. If a company is concerned about being acquired by another company, several anti- coup detat defenses can be implemented. As a minimum, most companies concerned about takeovers will closely monitor the trading of their stock for large volume changes. Poison Pills One of the most popular anti-takeover defenses is the poison pill.Poison pills represent rights or options issued to shareholders and bondholders. These rights trade in conjunction with other securities and they commonly have an expiration date. When a merger occurs, the rights are detached from the security and exercised, fully grown the holder an opportunity to buy more securities at a deep discount. For example, stock rights are issued to shareholders, giving them an opportunity to buy stock in the acquiring company at an completely low price. The rights cannot be exercised unless a natural offer of 20% or more is made by another company. This type of issue is designed to reduce the value of the Target Company.Flip-over rights provide for purchase of the Acquiring Company while flip-in rights give the shareholder the right to acquire more stock in the Target Company. mould options are used with bondholders, allowing them to sell-off bonds in the event that an un companionable takeover occurs. By selling off the bonds, large principal payments come due and this lowers the value of the Target Company. meretricious Parachutes Another popular anti-takeover defense is the Golden Parachute. Golde n parachutes are large compensation payments to executive management, payable if they depart unexpectedly. clunk sum payments are made upon termination of employment.The amount of compensation is unremarkably based on annual compensation and years of service. Golden parachutes are narrowly applied to only the most elite executives and thus, they are sometimes viewed negatively by shareholders and others. In relation to other types of takeover defenses, deluxe parachutes are not very effective. Changes to the incorporated Charter If management can obtain shareholder approval, several changes can be made to the Corporate Charter for discouraging mergers. These changes include Staggered Terms for Board Members Only a few board members are elected each year.When an acquiring firm gains control of the Target Company, important decisions are more difficult since the acquirer lacks full board membership. A staggered board usually provides that one-third are elected each year for a 3 ye ar term. Since acquiring firms often gain control directly from shareholders, staggered boards are not a major anti-takeover defense. Super-majority Requirement Typically, simple majorities of shareholders are required for various actions. However, the corporate adopt can be amended, requiring that a super-majority (such as 80%) is required for approval of a merger.Usually an escape clause is added to the charter, not requiring a super-majority for mergers that have been approved by the Board of Directors. In cases where a partial tone tender offer has been made, the super-majority requirement can discourage the merger. Fair price Provision In the event that a partial tender offer is made, the charter can require that minority shareholders receive a fair price for their stock. Since many states have adopted fair pricing laws, inclusion body of a fair pricing provision in the corporate charter may be a moot point.However, in the case of a two-tiered offer where there is no fair pri cing law, the acquiring firm will be forced to pay a blended price for the stock. Dual Capitalization Instead of having one class of equity stock, the company has a dual equity structure. One class of stock, held by management, will have much stronger suffrage rights than the other publicly traded stock. Since management holds superior voting power, management has increased control over the company. A word of caution The SEC no longer allows dual capitalizations although existing plans can remain in effect. RecapitalizationsOne way for a company to avoid a merger is to make a major change in its capital structure. For example, the company can issue large volumes of debt and initiate a self-offer or buy back of its own stock. If the company seeks to buy-back all of its stock, it can go private through a leveraged buy out (LBO). However, leveraged recapitalizations require stable earnings and cash flows for servicing the high debt loads. And the company should not have plans for major capital investments in the near future. Therefore, leveraged recaps should stand on their own merits and offer additional values to shareholders.Maintaining high debt levels can make it more difficult for the acquiring company since a low debt level allows the acquiring company to borrow easily against the assets of the Target Company. Instead of offspring more debt, the Target Company can issue more stock. In many cases, the Target Company will have a friendly investor known as a white squire which seeks a quality investment and does not seek control of the Target Company. Once the additional shares have been issued to the white squire, it now takes more shares to obtain control over the Target Company.Finally, the Target Company can do things to boost valuations, such as stock buy-backs and spinning off parts of the company. In some cases, the target company may want to consider liquidation, selling-off assets and paying out a liquidating dividend to shareholders. It is importan t to emphasize that all restructurings should be directed at increasing shareholder value and not at trying to level a merger. Other Anti Takeover Defenses Finally, if an unfriendly takeover does occur, the company does have some defenses to discourage the proposed merger 1.Stand Still bargain The acquiring company and the target company can reach agreement whereby the acquiring company ceases to acquire stock in the target for a specified period of time. This stand still period gives the Target Company time to explore its options. However, most stand still agreements will require compensation to the acquiring firm since the acquirer is running the risk of losing synergy values. 2. Green Mail If the acquirer is an investor or group of investors, it might be possible to buy back their stock at a special offering price.The two parties hold private negotiations and settle for a price. However, this type of targeted repurchase of stock runs contrary to fair and equal treatment for all shareholders. Therefore, green mail is not a widely accepted anti-takeover defense. 3. discolor Knight If the target company wants to avoid a hostile merger, one option is to seek out another company for a more suitable merger. Usually, the Target Company will enlist the services of an investment banker to locate a white knight. The White Knight Company comes in and rescues the Target Company from the hostile takeover attempt.In order to stop the hostile merger, the White Knight will pay a price more favorable than the price offered by the hostile bidder. 4. Litigation One of the more common approaches to stopping a merger is to legally challenge the merger. The Target Company will seek an injunction to stop the takeover from proceeding. This gives the target company time to mount a defense. For example, the Target Company will routinely challenge the acquiring company as impuissance to give proper notice of the merger and failing to disclose all relevant information to sharehold ers. 5.Pac Man Defense As a last resort, the target company can make a tender offer to acquire the stock of the hostile bidder. This is a very extreme type of anti-takeover defense and usually signals desperation. One very important issue about anti-takeover defenses is valuations. Many anti-takeover defenses (such as poison pills, golden parachutes, etc. ) have a tendency to protect management as opposed to the shareholder. Consequently, companies with anti-takeover defenses usually have less upside potential with valuations as opposed to companies that lack anti-takeover defenses.Additionally, most studies show that anti-takeover defenses are not successful in preventing mergers. They simply add to the premiums that acquiring companies must pay for target companies. deputy Fights One last point to make about changes in ownership concerns the fact that shareholders can sometimes initiate a takeover attempt. Since shareholders have voting rights, they can attempt to make changes wi thin a company. Proxy fights usually attempt to remove management by filling new positions within the Board of Directors. The insurgent shareholder(s) will cast votes to replace the current board.Proxy fights begin when shareholders request a change in the board. The next step is to solicit all shareholders and allow them to vote by procurator. Shareholders will pose in a card to a designated collector (usually a broker) where votes are tallied. Some important factors that will influence the success of a proxy fight are 1. The degree of support for management from shareholders not directly involved in the proxy fight. If other shareholders are satisfied with management, then a proxy fight will be difficult. 2. The historical performance of the company.If the company is offset to fail, then shareholders will be much more receptive to a change in management. 3. A specific plan to turn the company around. If the shareholders who are leading the proxy fight have a plan for improving performance and increasing shareholder value, then other shareholders will probably support the proxy fight. Proxy fights are less costly than tender offers in changing control within a company. However, most proxy fights fail to remove management. The upside of a proxy fight is that it usually brings about a boost in shareholder value since management is forced to act on scummy performance.It is worth noting that proxy fights are sometimes led by former managers with the Target Company who recognize what needs to be done to turn the company around. In any event, studies clearly show that changes in management are much more likely to occur externally (tender offers) as opposed to internally (proxy fights). Course Summary A merger is like a marriage the two partners must be compatible. Each side should add value so that together the two are much stronger. Unfortunately, many mergers fail to work. Overpaying for the acquisition is a common mistake because of an fractional valuation model.Therefore, it is essential to develop a complete valuation model, including analysis under different scenarios with recognition of value drivers. A good starting point for determining value is to extend the Discounted Cash Flow Model since it corresponds well to market values. Core value drivers (such as free cash flows) should be emphasized over traditional type earnings (such as EBITDA). Some key points to remember in the valuation process include 1. Most valuations will focus on valuing the equity of the Target Company. 2. The discount rate used should match-up with the associated risk of cash flows. . The forecast should focus on long-term cash flows over a period of time that captures a normal operating cycle for the company. 4. The forecast should be pictorial by fitting with historical facts. 5. A comprehensive model is required based on an understanding of what drives value for the company. 6. The final forecast should be tested against independent sources. If pre me rger phases are complete, we can move forward to integrate the two companies. This will require the conversion of information systems, combining of workforces, and other projects.Many failures can be traced to people problems, such as cultural differences between the companies, which can lead to resistance. Additionally, if you fail to retain key personnel, the integration process will be much more difficult. The best defense against personnel defections is to have a great place to work. If the company has a bad reputation as an employer, then defections will surely occur. Some of the risk factors associated with post merger integration are 1. What level of integration do we implement? 2. What can we do to retain key personnel? 3. How serious are the cultural differences between the companies? . What kinds of conflicts and competition can we expect during integration? 5. To what extent do the people of both companys understand the merger? 6. Who will govern and control the new compa ny? achiever with post merger integration is improved when 1. The two companies have a fib of effective planning and strategizing. 2. The two companies have a history of successful change management. 3. The merger will improve the strategies