mergers and acquisitions fundamental analysis for share valuation evaluation of a business...
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Mergers and acquisitions Fundamental analysis for share
valuation Evaluation of a business strategy
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In the real market, a firm creates value by earning a return on invested capital greater than the opportunity cost of capital.
The more a firm invest at returns above the cost of capital, the more value it creates
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A firm selects strategies that maximize the present value of expected cash flows or economic benefits
The value of a company’s shares in the stock market is based on the market’s expectations of future performance of the company.
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After an initial price is set, the return that shareholders earn depends more on the changes in expectations about the company’s future performance than its actual performance.
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NOPLAT (Net operating profits less adjusted taxes) represents the profits generated from the company’s core operations after subtracting the income taxes related to the core operations.
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Invested capital represents the cumulative amount the business has invested in its core operations – primarily property, plan and equipment and working capital.
Invested capital is the total of equity and total borrowings in the balance sheet of a company, reduced by the amount of non-operating assets.
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Net investment is the increase in invested capital from one year to the next
Net Investment = Invested capitalt+1 - Invested capitalt
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FCF is the cash flow generated by the core operations of the business after deducting investments in new capital.
FCF = NOPLAT – Net Investment
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ROIC is the return the company earns on each rupee invested in the business
ROIC = NOPLAT /Invested capital
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IR is the portion of NOPLAT invested back into the business.
IR = Net investment/NOPLAT
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WACC is the rate of return that investors expect to earn from investing in the company and therefore, the appropriate discount rate for the free cash flow
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‘g’ is the rate at which the company’s NOPLAT and cash flow grows each year
If the company’s revenue and NOPLAT grow at a constant rate and the company’s IR is also constant, its FCF will grow a constant rate
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Enterprise Value = FCFt+1 /(WACC-g)
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FCF = NOPLAT – Net Investment
FCF = NOPLAT – (NOPLAT x IR)
FCF = NOPLAT x (1-IR)
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g = ROIC x IR IR = g/ROICTechnically one should use the return on new or incremental capital
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FCF = NOPLAT x (1 – IR)FCF = NOPLAT x (1-g/ROIC)
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Value = [NOPLATt=1 ×(1-g/ROIC)]
WACC – gValue drivers : Growth; ROIC; and Cost of capital
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The value of a company equals the amount of capital invested, plus a premium equal to the present value of the value created each year.
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Economic Profit = Invested capital x (ROIC – WACC)
PV of economic profit =EP/(WACC-g)
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Value = Invested capital + PV of projected EVA
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Value = NOPLATT=1 x (1-g/ROIC)
WACC – g
Value = (1-g/ROIC) NOPLATt=1 WACC - g
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A Company’s earnings multiple is driven by both its expected growth and its return on capital
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NOPLAT = Invested Capital x ROIC
Value = Invested CapitalxROICx(1-g/ROIC) WACC - g
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Value = ROICx(1-g/RONIC)Invested Capital WACC – g
Drivers are : WACC;ROIC; and g
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Revenue growth Profit margin (per cent) Cash tax rate Working capital/Revenue (per cent) Capital expenditure/Revenue (per cent) Cost of capital (per cent) Value growth duration period (years)
◦ Value growth duration period represents the future period for which the entity has a foreseeable competitive advantage.