The M&A markets use four methodologies to assess the worth of most acquisition candidates. The methodologies are discounted cash flow, comparable public companies, comparable acquisitions, and leveraged buyout.
Now that we have studied historical financial analysis and financial projections, it’s time to gain an understanding of the methods by which buyers justify acquisition prices. In this chapter and subsequent chapters, we review the four approaches that instill a discipline in the M&A market.
Four Business Valuation Methodologies in the M&A Industry
- Discounted cash flow. A business’s intrinsic value equals the net present value of its dividends. Intrinsic value is sometimes called fundamental value.
- Comparable public companies. A firm’s value is determined by comparing it to similar public companies’ values.
- Comparable acquisitions. Calculate a company’s share price by considering its worth to a third-party acquirer.
- Leveraged buyouts. One prospective price for a business is its value in a leveraged buyout.
Assessing Each Methodology
These methodologies have pros and cons that are summarized here.
Discounted Cash Flow (DCF)
The pros of DCF are:
- DCF is theoretically appropriate and the subject of many textbooks.
- Corporate lenders use DCF on a regular basis for pricing loans and fixed-income securities.
The cons of DCF are:
- Equity professionals are reluctant to emphasize DCF. It is heavily ...